It is also important to keep in mind all of the regulations put in place post the financial crisis and scrutiny given to leverage have left us in an environment of much less leverage system-wide. Even here in the high yield market, leverage multiples have remained relatively moderate and interest coverage multiples improving, as much of the new issuance done has been for refinancing and has been done at lower interest rates, improving cash flow generation potential for issuers. Additionally, high yield valuations (as measured by the spread-to-worst) are currently above historical median levels and never got near historical lows during this most recent cycle, such as we saw proceeding past default spikes.9
This is not 2001/2002 or 2008/2009. The energy industry is a much lower portion of the high yield market than we saw with the media and telecom space at the turn of the century and we don’t see a massive systemic issue on the horizon to bring the market down. We’d expect defaults to be contained largely to the energy market, with the rest of the high yield market positioned well. There are certain areas of the energy space that we caution investors to avoid, namely many of the shale producers and energy service providers. Yet the recent repricing of risk and the widening of high yield spreads offers investors what we see as attractive value for many of the non-energy names in this market. The high yield market lends itself to active investing, especially in times like this where investors can capitalize on the opportunities and avoid the problem areas.
As active managers, that is just what we are doing now and have done through our history. Back in 2000, we weren’t sold on the media and telecom hype, as we focused on real business that we could understand with real cash flow prospects. We largely avoided the space going into the meltdown, and were able to buy at huge discounts telecom related securities that we saw as ultimate survivors and expected to profit at the demise of others. Earlier this year we reduced our energy exposure well under the levels held by the indexes, and we may look to selectively increase our exposure to the space and capitalize on opportunities at deep discounts when the timing is right—but for now, there is much to avoid in this space, and plenty of opportunities in non-energy related high yield names providing what we see as attractive yields and a moderate default environment for active investors.
1 Acciavatti, Peter Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” J.P. Morgan North American High Yield Research, April 10, 2015, p. 4-5.
2 Acciavatti, Peter, Tony Linares, Nadia Nelson, and Moliehi Pefole. “2002 High Yield-Annual Review,” J.P. Morgan, January 2003, p. 58.
3 Based on the Credit Suisse High Yield Index industry data as of 12/29/00. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market.
4 Acciavatti, Peter, Tony Linares, Nadia Nelson, and Moliehi Pefole. “2002 High Yield-Annual Review,” J.P. Morgan, January 2003, p. 70.
5 As of 7/31/15, Energy was 15.3% of the Credit Suisse High Yield Index and 16.35% of the J.P. Morgan US High Yield Index. JPM source, Acciavatti, Peter Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” J.P. Morgan North American High Yield Research, July 31, 2015, p. 51.
6 Acciavatti, Peter, Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “2014 High Yield-Annual Review,” J.P. Morgan North American High Yield Research, December 29, 2014, p. 63.
7 Acciavatti, Peter Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” J.P. Morgan North American High Yield Research, April 10, 2015, p. 4-5.
8 Data based on the Credit Suisse High Yield Index. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market. “Spread” referenced is the spread-to-worst.
9 Historical spread data covers the period from 1/31/1986 to 7/28/2015. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market. “Spread” referenced is the spread-to-worst.
This article was written by Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisory firm of the AdvisorShares Peritus High Yield ETF (HYLD).