INVESTMENTS & PENSIONS
and corporates will have to fund at much higher rates than they ’ ve previously been able to .
This , coupled with deteriorating economic data , including rising insolvencies and delinquencies , is making us more cautious on high yield .
In those funds with a bias towards higher yielding parts of the market we ’ ve been improving the overall credit quality . This reflects our view of the challenges that many high yield borrowers will face in an environment of higher borrowing costs , but also serves to defend against the risk of an economic slowdown .
Whilst it ’ s uncertain whether an economic slowdown will happen , we have far more certainty
around the risks that higher borrowing costs pose to the high yield bond market . We ’ re very wary of those borrowers with higher leverage , whose balance sheets were put together in a very different borrowing environment . Even factoring in further declines in interest rates and yields , these companies may not be able to refinance at an affordable level .
It ’ s notable that there ’ s been a clear dispersion between the yield demanded for stronger and weaker credits . While the spread on European BB and B-rated bonds fell , those on bonds rated CCC and below rose substantially .
FIGURE 2 . EUROPEAN CURRENCY HIGH YIELD INDEX SPREAD .
Source Macrobond , ICE BofA indices , to 31 / 1 / 24 .
This scenario , while challenging , can offer good alpha generating opportunities and can ultimately reward active portfolio management and a rigorous credit selection process . Although aggregate spread levels are not generous , we do still expect European high yield to deliver positive total returns in 2024 thanks to carry from the higher starting yield in the market .
ALTERNATIVES TO HIGH YIELD While we ’ ve reduced exposure to high yield companies , we ’ ve been happy to take some more exposure to subordinated debt in stronger companies . We ’ ve increased investment in corporate hybrid bonds . These are junior bonds but the issuing companies are typically large , investment grade-rated names .
We ’ ve also added to subordinated financials , including AT1 bank debt . Following the sell-off last March , both banks and regulators have taken steps to ensure the continuing health of the AT1 market and it has performed well .
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