Is high yield fixed income still attractively priced?
Based on Russell Investments’ cycle-value-sentiment framework for market analysis, high yield fixed income still offers an attractive opportunity at current levels.
An opportune time for high yield?
The market volatility of early 2016 makes this an interesting time for opportunistically-minded investors. One sector attracting attention is high-yield fixed income. High-yield saw a big sell-off in January and February and sharp rebounds in the last three weeks. The fixed income team here at Russell Investments has been tracking its fortunes closely. Although the yield spread over Treasuries has fallen back from the high of over 800 basis points earlier this year, the team continues to see value in the high yield sector, albeit with the likelihood of ongoing volatility.
Their analysis starts with the state of the economy (“cycle”.) On its own, this doesn’t paint a positive picture. As Yoshie Phillips, a Senior Research Analyst in that team, puts it “We have entered into a commodity-led default cycle and have seen signs of declining credit fundamentals. But the financial matrix for companies outside of commodity sectors are still by and large reasonably healthy. Our strategists also don’t think U.S. recession is a near-term risk, at least in 2016.”
The appeal of high yield fixed income lies, rather, in the attractive pricing (“value”.) The yield spread over higher-quality debt remains attractive, despite having moved off of its high, and the level of default that is priced in to the market is higher than the team’s expectations. Yoshie also points to the significant dispersion that exists between some companies and sectors where active managers can pick their spots.
The third leg of the team’s analysis is to overlay a sense of the state of the market (“sentiment”.) Yoshie points out that, in the late part of the credit cycle, investor sentiment can be volatile and quickly amplify market movements, both positive and negative: “With the broker dealers not providing liquidity anymore, the market has been very reactive to mutual fund flows and that has contributed to massive spread dispersion.” She notes that over 8% yield is the level that has drawn capital into the asset class in the past, especially in the context of muted projected returns on other asset classes.
Getting the timing right
Just because the valuation is attractive doesn’t make this the right move for everyone: risk budgets need to be considered. And timing, too, is (as always) a difficult call. So while the team sees the cycle-value-sentiment structure as pointing to a modest overweight for high yield, this is a situation where dollar cost averaging—legging in with a series of small moves rather than a single big jump—has some appeal.