By Ryan O’Malley, Fixed Income Portfolio Strategist, Sage Advisory
In recent weeks, Sage has become more cautious on lower-quality corporate bonds. Our caution is based on the following signals.
1. Abnormal Performance – High-yield bonds have performed well on an absolute-return basis this year, returning nearly 12% in 2019. Years of double-digit returns for high yield are rare and are typically followed by much weaker returns the following calendar year.
2. Relative Value – High-yield bonds have dramatically outperformed investment grade corporate debt this year, and particularly in the past few months. The spread premium paid by high-yield bonds compared to investment grade bonds has narrowed to its lowest level in 2019 and is near historic lows.
3. Signs of stress in the weakest parts of the market – Despite strong overall performance in the high-yield bond market, there are signs of stress. One such signal is the increase in the number of bonds trading at “distressed” levels. “Distressed” bonds are defined as those issuers who’s spread to the relevant U.S. Treasury exceeds 1,000 basis points, or 10%. The number of bonds trading at “distressed” levels has increased by 63% in the past 12 months.
As a result of this changing view, Sage has elected to trim high-yield exposure where we had individual bond positions – taking profits on some longstanding trades, including debt issued by Hilton Worldwide, T-Mobile, Ardagh Group, Cheniere Energy Partners, and Western Digital. Sage has also tactically shifted away from “crossover” credits, or credits that hold investment grade ratings from one agency and high yield from the other.
Investment grade spreads often follow trends in the high-yield markets, so Sage has also shifted its investment grade exposure away from riskier credits and towards higher-quality ones.
*Source on all charts is Bloomberg.
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