High-yield credit markets show signs of stabilising
High-yield corporate bond prices and credit spreads in developed markets are showing some signs of stabilisation, indicating investors see value and are returning to the sector, claims UBS.
High-yield spreads on average range between 500 and 600 basis points over government bonds, depending on duration, but are still currently trading north of 700bp with absolute yields of around 8.5%, notes Craig Ellinger, Chicago-based global head of credit research and high-yield for UBS Global Asset Management (Americas).
On a visit to Hong Kong yesterday, he tells AsianInvestor: “Prices and spreads seem to have stabilised in the last week or two. Although that’s not a long time-horizon, it does appear buyers are starting to step in where they can. There is a better balance between buyers and sellers.”
Credit spreads widened across the spectrum, not only as a result of government base rates falling amid a flight to quality but also due to deterioration in trading liquidity for credit products.
Although investors remain hypersensitive about default risk given the uncertain global economic outlook, Ellinger points to the strength of corporate balance sheets as reassurance in terms of companies’ ability to repay or roll over debt.
He also notes that a cushion of around 200bp has been created in the high-yield market alone to compensate investors for ongoing volatility and lack of liquidity in the market place.
“It looks like now is a reasonable time to add risk to credit,” says Ellinger. “People are hungry for good news. Should we at least see less bad news, you might see buyers step in and the market stabilise. I think that is what we are starting to see right now.”
High-yield bond issuance has dried up, with just five issues in total for Europe, the US and Asia-Pacific so far this month, according to data provider Dealogic. Across the three markets there has been a total of $230.7 billion in high-yield bonds issued to date this year.
Meanwhile a historically high level of almost $500 billion in debt has been used to refinance existing bonds since the end of 2008 (see chart, left).
“You can see something cyclical is going on,” adds Ellinger. “Post-Lehman going into 2009 there was a lot of debt coming due and the availability of credit was not there. That is the difference to now, where there is lots of liquidity.
“We are seeing some softness in economic data. Should we fall into a soft patch or a recession, with all that cash on their balance sheet, companies are going to be able to weather the storm.”
In terms of opportunities in the high-yield market, Ellinger notes that the mutual fund sector has seen billions of dollars of outflows over the past few months. “What is being sold is the stuff that can be bought and that happens to be the higher quality of paper in the market,” he says.
“What we have seen lately is a number of opportunities in the higher quality segment of the high-yield market, bonds which we think are very good from a credit quality perspective which have dropped 5-10% in value.”
Ellinger coordinates UBS Global AM’s global research effort and is also charged day-to-day with managing clients’ high-yield portfolios. He is in control of around $4 billion in AUM for four main strategies: US high yield, European high yield, global high yield, and short duration.
He says the bank’s high-yield fund products and separately managed mandates contain over 200 different securities. “We try to deliver beta and alpha and you can’t deliver beta unless you have a diversified portfolio,” he adds.
In February this year the bank launched the UBS Short Duration High Yield Fund, which Ellinger says has attracted $800 million from multiple share classes in different currencies, almost entirely from European and Asian clients. Since inception it has yielded 1.25%, according to Bloomberg.
Instruments in this fund are about one-and-a-half years in duration with an average BB credit rating and a yield of almost 8%, compared with four-and-a-half years and a B rating for traditional high yield.
Ellinger adds that UBS tries to add a layer of security by using covered bonds in its short-duration high-yield fund, which he says has seen roughly half the downturn in prices (2.5%) that its traditional high-yield fund has seen on the back of the recent sell-off. “We are finding that what is getting new AUM now is short duration,” he notes.