The recovery in the high-yield market remains unequal. A v-shaped bounce in expectations that fundamentals will recover and an influx of central-bank liquidity has supported the recovery in primary markets and driven markets tighter. This is well illustrated by the record amount of issuance in the US credit market this month.
In addition, a combination of attractive funding conditions in the historical context as well as an expected pick-up in volatility in Q4 have driven the charge to access markets. Meanwhile, high-yield credit has continued to prove attractive on a relative basis. Indeed, in early July it became clear that high-yield credit should remain in favour after it outperformed investment grade credit.
That said, on closer inspection, it is evident from the shape of the recovery that investors continue to differentiate between issuers. Although the first six months of the year were not as bad as anticipated, investors recognise that the coronavirus pandemic has severely impacted the cash flow generation of many businesses. As figure 1 demonstrates, BB-rated credits are now generating positive returns, while B-rated credits continue to flirt with zero as we approach the final three months of the year. CCC-rated credits – the lowest tier of high yield – are floundering amid elevated levels of defaults and low recoveries. Indeed, this segment of the market has fewer tools to withstand cash-flow hits.
In the coming months, asset allocators must strike the right balance between the reach for reliable income that credit offers and the need to manage bottom-up idiosyncratic risk that continues to play a significant role in the current market environment.
Figure 1. An unequal recovery
Source: Federated Hermes, ICE Bond Indices, as at 25 August 2020.
