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November 2023 / FIXED INCOME

The Case for High Yield

Improved credit quality and attractive yields support the asset class.

Key Insights

  • The global high yield market has performed well across different market cycles, thanks to high coupons and a return to par at maturity.
  • Issuer fundamentals have remained resilient despite the challenging macro backdrop.
  • Improved credit quality is paired with the most attractive yields available in over a decade.

WHY HIGH YIELD BONDS?

Has Produced Durable Returns Over Time

Global high yield bonds have broadly performed favorably across different market cycles. Since 1980, the high yield market has only experienced seven calendar years of negative returns. Perhaps even more impressive is that there have never been two consecutive years of negative returns in the asset class covering 40 years (Fig. 1). Following years of negative returns, the asset class usually experienced years of either outsized gains or several years of modest returns. This resilient return pattern is simply due to “bond math.” The high yield market may experience bouts of weakness, resulting in lower dollar prices; however, it still generates high coupons, and eventually bonds are pulled to par as they near maturity, fortifying the returns recovery.

High Yield Bond Annual Returns

(Fig. 1) Only seven negative return years since 1980.

The bar chart shows that annual returns for high yield have mostly been positive, ranging from a high of 59% in 2009 and a low of -27% in 2008. In 2022, high yield returned 5%.

As of June 30, 2023.
Past performance is not a reliable indicator of future performance.
Source for annual returns data: J.P. Morgan Global High Yield Index. Please refer to Additional Disclosure for further source information.

Leveraged Credit Has Generated Compelling Risk-Adjusted Returns

While return is certainly an important consideration when evaluating an asset class, volatility must also be evaluated. The Sharpe ratio, which measures return in excess of the risk-free rate, per unit of standard deviation, can be a useful metric to compare risk-adjusted returns across asset classes. Over the last 10 years, high yield bonds have had the second-highest risk-adjusted returns, trailing only below investment-grade bank loans (Fig. 2). Consequently, we believe that investors have been fairly compensated for the additional performance risk when moving to below investment-grade credits.

Statistics Across the Markets

(Fig. 2) High yield compares favorably to other segments.

The bar chart shows how high yield’s 10-year Sharpe ratio of 0.5 is behind only the 0.6 ratio of bank loans and higher than that of 11 other asset categories.

As of June 30, 2023.
Past performance is not a reliable indicator of future performance.
Bloomberg Indices: U.S. Treasuries: US Treasury Index; Treasury Inflation-Protected Securities (TIPS): US TIPS Index; ABS: Asset-Backed Securities Index; MBS: U.S. Mortgage-Backed Securities Index; CMBS: CMBS ERISA Eligible Index; U.S. Aggregate: U.S. Aggregate Bond Index; Agencies: U.S. Agencies Index; U.S. Corp. Investment-Grade: U.S. Corporate Investment Grade Index; Muni: Municipal Index.
Emerging Markets represented by J.P. Morgan Global Emerging Markets Bond Index; Emerging Corporate Bonds represented by J.P. Morgan CEMBI Broad Diversified Index; Bank Loans represented by the S&P Performing Loan Index; High Yield Bonds represented by the J.P. Morgan Global High Yield Index. Please refer to Additional Disclosure for further source information.

Low Default Rate Profile

Although the macro backdrop remains challenging for risk assets, high yield fundamentals continue to be resilient. Since the global financial crisis (GFC), high yield market new issuance has been dominated by refinancings as issuers capitalized on historically low interest rates. Additionally, record capital markets activity in 2020 and 2021 (post-COVID drawdown) at cheap financing rates strengthened balance sheet liquidity and increased interest coverage metrics to peak levels. The high yield default rate marginally increased to 1.6% in June 2023 from 0.8% in December 2022 but remains well below its long-term average of 3% (Fig. 3).

Global High Yield Market Default Rates

(Fig. 3) Defaults are running below the historical average.

The line graph shows that high yield default rates remain below average and well below peaks over previous periods financial turmoil since 2000.

Past results are not a reliable indicator of future results. As of June 30, 2023.
Source: J.P. Morgan Chase & Co. Please refer to Additional Disclosure for further source information.

WHY HIGH YIELD BONDS NOW?

Evolution to a Higher Credit Quality Market

The current high yield market is drastically improved compared with the GFC in terms of credit quality. Using the Credit Suisse High Yield index as a proxy, the high yield market has migrated up considerably in credit quality since the GFC. In 2007, only 37% of the index had at least one BB rating; today, that figure is roughly 60% (Fig. 4). Partially the result of record fallen angel volume (USD 240 billion) entering high yield in 2020, the average company in the high yield market has a larger market cap and generates more free cash flow today than prior to the GFC. Therefore, we feel the asset class is in a position of strength should the economic outlook weaken.

BB Composition of the High Yield Market

(Fig. 4) High yield credit quality has steadily improved.

The line chart shows how the percentage of the high yield market with a BB rating has risen from 37% in 2007 to 60% in 2023.

As of June 30, 2023.
Source: Credit Suisse. High Yield Market is represented by the Credit Suisse High Yield Index. Please refer to Additional Disclosure for further source information.

Today’s Yields Have Rarely Been Observed Over the Last 10 Years

Rate and credit spread volatility since the first quarter of 2022 have resulted in attractive yields and dollar discounts not seen since the GFC, attributed to unprecedented quantitative tightening and related recession fears. As of June 30, 2023, the yield to worst on the J.P. Morgan Global High Yield Index was north of 9%. This is well above the average level of 6.86% observed over the last 10 years (Fig. 5). Considering the credit quality of the market is much higher today, the absolute yield on the asset class screens attractive, especially compared with similar dislocation levels during the energy crisis (2015–2016) and the pandemic sell-off, where both the quality and fundamentals of the market were lower than levels observed today.

Yield to Worst of the High Yield Market

(Fig. 5) Attractive yields given higher credit quality.

The line chart shows how the yield to worst of the high yield market, at above 9%, has been well above its average since December 2012.

As of June 30, 2023.
Past performance is not a reliable indicator of future performance.
The Yield of the High Yield market is represented by the J.P Morgan Global High Yield Index.
Source: J.P Morgan. Please refer to Additional Disclosure for further source information.

Yields Indicate Attractive Valuation

While we cannot predict future returns from current yields, we can use history as a baseline for when the high yield market had similar yield levels and what forward, or subsequent, returns looked like. Since 2012, the high yield market has crossed the 9% yield threshold five times. In each instance, the one-year forward return picture has been in the mid-double-digit range (Fig. 6). Since 2012, the median 12-month forward returns have been in double digits when yields in the market have exceeded 7%.

Historical Global High Yield Returns Once Yields Reached Various Thresholds

(Fig. 6) History provides a baseline for similar yields.

The bar chart shows that yields to worst above 9% over the same period have resulted in a subsequent 12-month return of 16.0%.

As of June 30, 2023.
Past performance is not a reliable indicator of future performance.
Returns since January 1, 2012. Performance periods shown once index yields moved through the yield threshold and had not been at that level for the preceding 30 business days.
Global High Yield Market represented by the J.P. Morgan Global High Yield Index. Please refer to Additional Disclosure for further source information.

Additional Disclosure

J.P. Morgan–Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2023, J.P. Morgan Chase & Co.
All rights reserved.

Credit Suisse–© 2023 CREDIT SUISSE GROUP AG and/or its affiliates. All rights reserved.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

IMPORTANT INFORMATION

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.  

It is not intended for distribution to retail investors in any jurisdiction.

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