The elevated volatility in markets continues to surprise investors. High yield has been particularly affected, as the coronavirus pandemic and the inability of the Organisation of Petroleum Exporting Countries and Russia to reach a supply-cut agreement has roiled markets.
Global high yield delivered its largest-ever positive one-day return last week, supported by central-bank announcements, fiscal stimulus and the de-risking that has taken place since 21 February. High yield is attractive at its current valuations: an analysis of the past two decades shows that the asset class tends to offer a better pay-off profile in the year after spreads breach 1,000bps (which happened last week).
In terms of fundamentals, considerable uncertainty remains about the end impact of the coronavirus. However, there may be light at the of the tunnel. Credit quality within the global high-yield market is currently much higher than during previous drawdowns. This is largely because there has been more leveraged financing in the loans market over the past five years, while the rise in fallen angels – or firms downgraded to high-yield status – means the average credit rating of the high-yield market is now BB.
The BB-rated share of the market stands at an all-time high of 58% (see figure 1) while the CCC-rated segment is currently 8% – a record low. This trend is likely to continue. While market disruption means that the rebalancing of indices has been postponed, at the end of April we should see a flurry of fallen angels enter the global high-yield index.
Figure 1. The composition of the high-yield market is changing
Source: ICE Bond Indices, as at March 2020.