Does «high yield» automatically mean higher risk?

On Tuesday, 28.05.2024, I flew to London to talk with Sunita Kara from Aviva Investors over coffee on the subject of «high yield». Unfortunately, there wasn’t enough time for lunch. However, I can highly recommend the restaurant «The Ivy City Garden». It is very large, has a wonderful ambience, extremely friendly service and of course a prime location in the financial district. I learnt a lot of valuable facts about this highly interesting asset class. However, we still had some time to talk about things other than finance. It was a great conversation! Thomas J. Caduff, CEO, Fundplat LLC

• Caduff: Mrs. Kara, where does the yield start and end with the term «high yield»?

Kara: It’s all relative to what other spread products and cash are offering. Back in 2014 and 2017, when HY yields were about 5 percent investors found the asset class attractive and were generally positioned overweight; that was because the alternative of cash was close to zero and investment grade was yielding about half of HY. Today, with HY yields higher at 7.6 percent, historically this has resulted in positive total returns about 85 percent of the time. Whilst the credit spread compensation component of yield is tight, we do find comfort in the cash price of bonds trading on average at 93 cents. If issuers look to pay back investors at 100 cents at maturity, then this offers an attractive price appreciation return in addition to the coupon return.

• Caduff: «High yield» automatically means higher risk. How can you manage this efficiently?

Credit selection is critical and even moreso today. Sunita Kara

Kara: The key risk for investors in HY remains the default risk and the associated capital loss from recoveries at well below 100 cents. Strategically, by investing in higher quality HY (bonds rated in the «BB» and «B» categories) is an optimal starting point given long-term average default rates in higher quality bonds is less than 3.5 percent. This compares with default rates of about 17 percent in lowest quality «CCC» rating category. However, credit selection is critical and even moreso today. Idiosyncratic credit risks have increased where some issuers rated «BB» are carrying elevated credit risk akin to lower quality. The way to manage risk is therefore deep fundamental credit analysis with a rigorous understanding of bond documentation and covenants to ensure possible downside scenarios are appropriately assessed and considered when investing.

• Caduff: What strategies do you offer Swiss investors?

Kara: We offer global developed market high yield strategies, both all maturities and short duration (maturities less than 5 years). We believe that the global opportunity set allows investors to access a deeper and more liquid pool of bond issues. In addition, global also provides a diversification benefit in terms of broader sectors (for example US HY has more energy bonds, European HY more financial bonds) and different macro and credit cycles (Europe is likely to enter a period of monetary easing ahead of the US and thereby being supportive for credit). The yield on both all maturity strategy and short duration is similar and short duration offers attractive carry given the inverted government bond curve combined with a fairly flat credit spread curve.