Artisan Canvas

Where Might Yield-Seekers Turn Now?

A year of increased asset purchases, new emergency facilities and lower interest rates—unleashed by global central banks in response to the pandemic’s economic disruption—has made it increasingly challenging for investors to find yield in today’s market. As it stands, only about 30% of the world’s bonds trade with yields over 1%. For investors looking to generate income over and above inflation, high yield credit stands as one of the last remaining asset classes that still offers compelling yield opportunities on an absolute and risk-adjusted basis.

Leveraged Credit Provides Some of the Highest Relative and Risk-Adjusted Yields
Yields by Asset Class and Volatility

Source: Artisan Partners/Bloomberg/Morningstar. As of 31 Jan 2021. Leveraged loan yields are based on 3-year takeout. High yield bond yields are to worst. High yield Bonds: ICE BofA US High Yield Index; Leveraged Loans: JPMorgan Leveraged Loan Index; 10-Yr Treasury: FTSE Treasury Benchmark 10 Yr; IG Corporate Debt: ICE BofA US Corporate Index; JPMorgan EMBI Global Diversified Index; High Dividend Equities: S&P 500 High Dividend Index; Real Estate Investment Trust: MSCI US REIT Index; Master Limited Partnerships: Alerian MLP Index. Past performance is not a reliable indicator of future results.

That said, the opportunity set isn’t nearly as attractive is it was at the depths of the COVID crisis. Plenty of risk-seeking capital has sought dislocated capital structures and provided the market’s most marginal borrowers an array of options to address their liquidity needs—a trend that has gained even more momentum recently with euphoric equity valuations and wide open primary markets.

As a result, all-in yields for high yield bonds are at their lowest levels in history while the amount of distress in the market has fallen to multiyear lows. Today, more than 70% of high yield bonds trade at their next call price, implying that at current valuations, the prospect for broad-based price improvement is probably limited. But despite central bankers’ heavy-handed policies, overarching macro uncertainty means there are still plenty of compelling total return opportunities for fundamental credit investors.

Spread Dispersion Presents Opportunities for Credit-Specific Outperformance
20th Percentile vs 80th Percentile

Source: Artisan Partners/ICE BofA US High Yield. As of 31 Jan 2021. Spreads based on spread to worst basis. Diffrerence represents the difference between the 80th percentile and 20th percentile of spreads.

For one thing, spreads may have come full circle, but the recovery has been uneven, leaving plenty of spread dispersion across sectors and capital structures. A broad range of COVID-impacted industries trade well wide of their levels 12 months ago, representing an uncertainty premium that can be exploited through an active approach. While many of these businesses will likely face ongoing near-term disruption—particularly leisure, transportation, and airlines—they operate with sufficient access to capital to overcome near-term cash burns and to extend maturities beyond the pandemic. Most importantly, they operate business models that have reason to exist in a post-pandemic world. While many of these businesses likely emerge from the pandemic a bit more levered, sufficient demand in the medium term should allow them to grow into their balance sheets over time.

Credit-Specific Opportunities Are Still Widespread
YoY Change In Spreads Among Select Industries

Source: Artisan Partners/ICE BofA US High Yield. As of 31 Jan 2021. Spreads based on spread to worst basis. Industries are represented by constituents in the ICE BofA US High Yield Index.

Then, too, there remain options beyond high yield bonds and across the capital structure—e.g. leveraged loans. The strong 2020 performance for high yield bonds has caused the yields for bonds and loans to diverge, leaving little carry differential between the two asset classes. This means some investors can limit their interest-rate sensitivity, pick up more structural seniority and generate additional yield by rotating from high yield bonds into loans. And in fact, we are starting to see some of this play out in the market. Consider: Each new round of COVID stimulus has been met with higher interest rates and inflation expectations. As a result, the asset class experienced its strongest stretch of inflows since January 2017 over 2021’s first six weeks as long-term rates have risen 50bps.

Identifying Value Across the Capital Structure
Comparing Yields: High Yield Bonds vs Leveraged Loans
Source: Artisan Partners/ICE BofA/JPMorgan. As of 31 Jan 2021. Past performance is not a reliable indicator of future results.

Headlines may decry the absence of opportunities for yield in the market, but for the discerning student of credit markets, that clearly is far from the case—even after an unprecedented year of monetary policy like 2020.

ICE BofAML US High Yield Index measures the performance of below investment grade $US-denominated corporate bonds publicly issued in the US market. J.P. Morgan Leveraged Loan Index is a market-weighed index that mirrors the investable universe of the US dollar denominated leveraged loan market. FTSE US 10-Year Treasury Index is an average of the last six 10-Year Treasury bond month-end rates. ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market. J.P. Morgan Emerging Markets Bond Index Global Diversified tracks total returns for U.S. dollar denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities. MSCI US REIT Index is a free float-adjusted market capitalization weighted index that is comprised of equity Real Estate Investment Trusts (REITs). S&P® 500 High Dividend Index is designed to measure the performance of the top 80 high dividend-yielding companies within the S&P 500® Index, based on dividend yield. Alerian MLP Index is a capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities.