If a recession was in the cards prior to Federal Reserve Chair Jerome Powell’s announcement yesterday that the Fed may reaccelerate rates, it is very much in focus now. The prospect of even more, faster rate hikes piled on top 450 basis points (bps) of hikes in the last year is a gut punch for markets and investors that risks igniting a recession. For those investors who want to prepare for that possibility, it may be time to revisit the merits of high yield corporates.
Investors and advisors alike will be familiar with the basics of a high yield corporate debt security, with the higher risk of default offset by the potential for attractive yields. So why add more risk in such a complicated environment? Simply put, the potential spreads are so potent that they may be worth taking on that risk, especially in a downturn that may see other sources of return suffer.
According to research from WisdomTree Investments, should markets settle on a hard landing vision for the future, high yield spreads of 412 bps as of February 28 could widen by an additional 478 bps. Looking at the past 10 years, much of the high yield data is skewed by the huge 1,264 bps spread widening during the 2007 to 2009 financial crisis period — removing that, a high yield option-adjusted spread adds an additional 161 bps of widening — and could provide a return of 6.4% for this year.
What’s more, high yield corporates and their “lofty” yield levels could even help investors break even with a base case of just another 303 bps increase in spreads — a worthwhile option to consider for those looking at long-term fixed income holdings.
One way to play such a potentiality may be the WisdomTree U.S. High Yield Corporate Bond Fund (WFHY), which has added a notable $31 million in net inflows over the last month and $17.6 million in the last five days. WFHY tracks the WisdomTree Fundamental U.S. High Yield Corporate Bond Index, targeting U.S.-domiciled high yield debt with no maturity mandate, considering factors like free cash flows to equity and screening for the bonds most likely to default, charging 38 basis points.
Fixed income offerings can help more than just RIAs, with institutionals also having options in the world of debt securities. Floating-rate notes (FRNs) deserve a mention too, with their ability to navigate topsy-turvy rates offering some notable flexibility.
Recessions are bad news, make no mistake, with investors looking high and low for sources of yield and return that can buoy their holdings in tough times. High yield corporates have their risks, but with the yields available, they can be part of a counter-recession strategy and are worth keeping an eye on in the weeks and months ahead.
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