Credit boost
One of the key reasons for optimism and faith in the sector, adds Braganza, is that the market has seen a major improvement in credit quality in recent years.
Much of this improvement, she adds, has been driven by post pandemic efforts to reduce corporate debt levels on balance sheets. This leverage had grown partly to support furlough payments and other contingencies - common during the disruption and market volatility of the global COVID-19 crisis.
“Management teams within the high-yield debt sector have generally done a good job in reducing leverage and debt levels post pandemic. Interest coverage and EBITDA3 margins are now strong across the market and underlying companies within the sector are generally robust.
“Despite the pandemic, energy shocks and other factors such as rising wages and supply chain issues, we believe the high yield market remains robust. Our analysis suggests the percentage of ‘triple C’ rated debt in the market is at its lowest ever level and now makes up a very small part of the high yield market.
“High yield markets, both in the US and Europe have, in our view, improved in credit quality. The average rating in European high yield is now ‘BB’ and the US is ‘B+’, this compares to a deterioration in average credit quality in the investment grade (IG) market to ‘BBB’,” she adds.
Braganza favours exposure to short-dated high yield bonds, whose comparatively short life span she believes can help mitigate against oscillating market concerns over inflation or recession. She says short-dated high yield debt investment can provide investors with enhanced yield and protection from being short in duration with an inverted yield curve, while providing good visibility of cash flow from the companies their portfolios invest in and reducing longer term macroeconomic concerns.
“The beauty of short-dated high yield is that investors are being compensated for staying put in terms of duration. We believe exposure to short-dated high yield can also offer investors some protection against gyrations in the US Treasury curve,” she says. “We don’t need interest rates to move to make money.”
According to Braganza, the wider high yield debt market also offers other comfort factors, including favourable interest coverage levels and widespread opportunities for investors to ‘call’ their bonds early, if needed.
“Global profit margins remain generally strong and many high-yield issuers have extended their maturity profiles. We see companies progressing on their business plans and are thus willing to refinance their 2025 and 2026 bond maturities at current interest rates. Good companies tend to ‘roll’ their capital structure well in advance of maturity and 99% of bonds in the high yield sector are callable,” she adds.
Private debt
Looking ahead, Braganza expects high yield bond default rates to stay low, predicting a range of 2-3% for Europe and the US. An important factor in the stability of the market she adds, has been an influx of support from private debt market, which has enabled troubled high yield issuers to access new capital.
“Increasingly, we have seen distressed companies going to the private debt market to refinance. This is a positive in that it means weaker companies are being weeded out of the market, which improves the credit quality of the market still further and helps keep defaults low.”
Europe and the US have recently seen lower levels of gross issuance than in previous years thanks to slower growth, lower overall mergers and acquisition activity and the uncertainty created by COVID-19 related disruptions, adds Braganza. With market issuance varying across markets, she adds that it can be beneficial to adopt a global approach, seeking pockets of value and differentiation across a range of geographies.
“Relative market opportunities have shifted over the decade between Europe and the US. Being able to move between currencies means you can take advantage of exactly where opportunities lie,” she adds.
While bullish on the high-yield debt market she points out that no asset class is risk-free and that detailed analysis and dialogue with issuers is key to avoiding unexpected problems.
“When considering investment in high yield it is important investors meet the companies and talk though the issues they face. Investors will have some clear expectation of what they would like to see in terms of cash generation, and it is important to assess the budgeting and cashflow of corporate issuers. Governance should always be a key investor consideration and it is very important to identify the risks that could lead to a sharp deterioration in an issuer’s credit quality,” she concludes.
