The unprecedented and largest-ever rebalancing of the high-yield index is now behind us. So far, the market has absorbed the fallen angels – issuers downgraded from investment-grade status – in an orderly fashion. This is in part due to the Federal Reserve’s pledge to support fallen angels, as well as improving market sentiment.
The global high-yield index has expanded by nearly $200bn to $2.3trn. Its underlying composition has also changed and BB-rated credits now make up more than 60% of the index, compared to 40% before the financial crisis.
As expected, the largest number of downgrades came from the energy and automotive sectors. Both industries are in the eye of the storm and currently account for a quarter of all volatility in the high-yield market (see figure 1).
Figure 1. Risk by sector in the high-yield market
Source: ICE Bond Indices, as at May 2020.
The sectors are also home to a number of weaker investment-grade companies, particularly in the US. Formulating views on these industries will be important over the next six to 12 months, as both offer a good mixture of risks and opportunities (find out more by watching our latest Industry Insight).
The rebalancing also accelerates the transition from a high-yield market that is dominated by smaller leveraged buyouts to one that is focused on larger multi-layered global capital structures. The average size of a capital structure has almost doubled from about $800m during the financial crisis to $1.5bn today.
We will likely see more downgrades as earnings season gets underway, meaning that fallen angels will continue to change the shape of the high-yield market. As the asset class becomes increasingly global and characterised by large-cap companies, an unconstrained approach to credit investing should help investors seek out opportunities in the months ahead.