We are all faced with an extremely uncertain outlook. At times like this, I like to consider the resilience that high yield has shown in previous cycles. For example, our favoured sub-set of the market, excluding CCCs and energy, has a spread of 715 basis points (bps) as I type. Historically, when the market has pushed through 700bps, the return profile of a medium to long-term investor committing capital on that day has been excellent, as the chart below highlights.
As the economy deteriorates, defaults are clearly a risk to high yield returns. In early April, JPM published a note to clients indicating they expect the European high yield market to have 6% defaults as a base case for 2020. That would be a quicker impact than in 2008 when defaults did not peak until the following year but if we expect a shorter, sharper downturn this time, I would not quibble with that number too much.
If we take that 6% as a starting point, the US high yield market, with its high exposure to the domestic energy sector, could well be higher than that.
We are encouraged that of all the sub-investment grade debt that comes due between 2020-2024, only 4% is to be repaid in 2020 and 68% in the final two years (2023 and 2024). This provides a good degree of cushion against refinancing risk.
The next obvious risk is an inability to service interest payments and this is partially captured within credit ratings. Currently, 86% of our portfolio is in mid-B rated credit and higher: according to Moody’s in mid-February 2020, only 16% of companies rated B2 had weak interest cover and cashflow metrics and this proportion gradually drops as we move towards the higher rated parts of the market.
Of course, the economic impact is going to be huge in the near term and those company metrics will change rapidly. We are comforted, however, that the Fund does not have significant exposure to thematic and cyclical sectors such as energy, mining, leisure and retail. For example, the Fund has 0.4% in retail (petrol forecourt), around 2% in energy, 1% in mining and 0.5% directly in casinos/hotels/tourism.
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Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
Investment in the GF High Yield Bond Fund involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Fund may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.
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