Global high yield has delivered almost 16% since the start of 2019 and investors are increasingly asking where the next leg of capital appreciation will come from. The sell-off in Q4 2018, easier monetary policy, improved fundamentals and strong demand for spread products have all resulted in outstanding performance from credit markets over the past 13 months.
This has caused a large part of the market to trade above the level at which the company is able to call bonds in the near term. One solution could be to reach further down the ratings spectrum, but in our view the macroeconomic environment is not good enough to justify this – especially given the disruptions caused by the coronavirus epidemic.
Figure 1 shows the share of high-yield bonds in each sector that are trading above their near-term call price. While roughly 50% of bonds in the services and consumer-goods sectors are trading above this level, the number is less than 20% in banking and energy.
Figure 1. Bonds trading above their near-term call price
Source: Federated Hermes, as at January 2020.
To capture any further upside, investors need to look for opportunities in sectors that inhabit the right-hand side of the chart. The current state of affairs means that there is very strong demand for the capital instruments of banks in both primary and secondary markets – which is confirmed by the outperformance of additional tier-one instruments this year.
There is also likely to be more refinancing supply in sectors like healthcare and retail, where a higher share of bonds are trading above their 2020 call price. In this environment, it is more important than ever to combine a top-down and bottom-up look at the credit spectrum in order to identify the parts of the market that offer the best risk-adjusted returns.