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Weekly Credit Insight

Chart of the week: seeking the upside in global high yield

Time refuses to stand still and with the first quarter of 2020 drawing to a close, now is a good time for asset allocators to review the market and rebalance their portfolios towards instruments offering attractive risk-adjusted returns.

The extent of the fallout from the coronavirus pandemic is still uncertain. Measures taken by governments are not yet standardised, the length of the outbreak is still unknown, and the virus not entirely understood by the scientific community.

After delivering strong returns in 2019, the high-yield market has taken a beating this year. The impact of the market sell-off on the global corporate universe is not yet known. Companies are doing what is within their control, including cutting dividends, buybacks and capital expenditure, and finding ways to optimise cost structure.

Understandably, credit markets are now pricing in a much higher level of defaults over the next 12 months. Many companies, particularly lower-rated ones, were already struggling with the economic slowdown that started in 2018, as well as disruption from changing consumer behaviour and technological innovation.

With global high-yield spreads recently rising above 1,000bps, we think it is instructive to take a historical perspective. Since the late 1990s, there have been about 57 weeks when spreads were above this level. In only three of these did investors lose money over the following year, and for the rest the average return was almost 40% (see figure 1).

Figure 1. Global high yield: what happens when spreads breach 1,000bps?

Source: ICE Bond Indices, Federated Hermes, as at March 2020.

There are still many unknowns, and history does not always repeat itself (although it often rhymes).  Nonetheless, a historical viewpoint suggests that there is considerable potential to secure some upside going forward.

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