Advert

High Yield debt and the coupon clip

Photo: Shutterstock

Photo: Shutterstock

In 2007, all seemed rosy for investors with global markets reaching pre-crisis highs; a golden period whereby investors cheered a rally across all asset classes for quite a while.

Whoever thought that those rosy days were up for a turbulent ride? At the time, rating agencies were well respected and credible, whereas politicians were viewed as normal human beings with the eagerness of making a better world.

With the benefit of hindsight, that period was suicidal for investors who continued to pile on to further assets at record high valuations.

Those were terrible trades, whereby within months proved to be a point of plummeting momentum of net worth for investors. Then in continuation, investors were also punished over a 10-year period due to the eurozone crisis in 2011, and the commodity crisis in 2014/2015.

At the time, high yield was considered one of the most promising asset classes with investors gaining remarkable returns. Investors bought junk issuance as they were certain that the asset class would continue to prevail in terms of performance and robustness of the issuers.

Interestingly enough was the additional return of high yield debt over government bonds with the same maturity; using technical jargon the spread over the benchmark, were at lows of 200bps (2%) when compared to today’s 400bps (4%).

Nevertheless, despite a turbulent phase, looking closer at how high yield debt performed from those terrible entry points explains why the asset remains an attractive venue for investors.

The numbers for the period March 2007-to date enforces the attractiveness of the asset class. In fact, from a total return perspective in the said period, Global high yield returned an impressive 119%, according to the BOFA Merrill Lynch index.

Dissecting the return figure, it is interesting to note that 120.59% were generated from income return, whilst a negative 1.6% was generated from price return.

The negative return shows that volatility prevailed in the crisis period with high yield declining by circa 35% in 2008. This further reinforces our view that the carry trade, especially within an asset class such as high yield debt, is a pivotal element of total returns.   

When considering crisis scenarios one would wonder which asset class should be retained within a portfolio. Looking at historical numbers the answer is simple; remain invested in HY.

Clipping on to the coupon is one way of generating strong total returns in a portfolio. That said it is imperative to select the right companies. The HY market is a mechanism of transferring cash flows from cash generating companies into coupon flows to those investors who were willing to finance the company’s operations.

In this regard, this is why it is crucial to bond pick companies that generate positive cash flow. In fact, analysts emphasise much of their work on scrutinising cash flow statements. 

Going forward, in line with the possible rising interest scenario, many investors are skeptical on the 30-year old bull bond market and its impending possible volatility.

However, when one considers the above rationale, the asset class seems to be one to hold-to. Undoubtedly, other market factors should be factored-in when positioning a portfolio.

However, what is important is that investors should also take into consideration that in practice, theory and market sentiment sometimes differ.    

Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

Advert
Comments not loading? We recommend using Google Chrome or Mozilla Firefox with javascript turned on.
Comments powered by Disqus  
Advert
Advert