What does 2021 have in store for high yield investors? Based on the starting point for yields (4%) and our team’s track record of decent stockpicking, even when dispersion in bond valuations is low, a 5% return for a sterling investor (4% for euros) is a realistic base case, in our opinion.
We also believe this 4-5% return outlook stacks up well versus other assets. Government bonds have never been more at risk of capital loss in a rising rates environment, just as the spectre of inflation is picking up. Meanwhile, equities are very capable of outperforming, but, as history tells us, not likely by that much as a collective, and would likely have double the drawdown, or worse, than high yield if risk markets hit a skiddy patch.
High yield bond interest payments are also non-negotiable, unlike equity dividends, making it a very dependable source of income. We continue to believe core, quality high yield has excellent risk/reward characteristics versus other potential homes for your hard-earned cash.
Entering my twelfth calendar year as a manager of high yield bond funds, it is hard to gauge exactly how much of a good long-term track record is luck and how much is skill. Starting off in 2010 as I did, enormous support for credit markets has been in place throughout; we have been running with a tailwind for the entire race.
Rarely has the ‘central bankers have our back’ trade been more evident than in the second half of 2020. Despite fairly sizeable uncertainty, the weakest companies and bonds in our market rallied hard, with CCCs producing a return of over 18%, vastly outperforming BBs.
Today, the difference in spread, the credit risk premium, between the average BB and CCC is around 5.5%, versus a ten-year average of around 7.5%. The lowest this has been in the last decade is a little over 4%. In other words, if we judge the high yield market by its weakest links, it is telling us the economic outlook is about as rosy as it gets.
I believe in our investment process, even though we could have made a little more for our clients if we had reached down the quality spectrum, backing to a greater extent the measures in place to support credit markets. But then, what is it we are trying to achieve for our clients? My view of this is that we are trying to provide a good source of income and returns, in good times and bad, for the long-term. In this regard, I believe our process would have achieved this goal even if central bankers had not been standing behind us with a wind generator.
As is typical of our Liontrust GF High Yield Bond Fund, going into 2021, we are light in CCCs and avoiding accumulations of thematic, commodity-like cyclicals. We are sanguine on the default risk within our Fund relative to a market that is being well supported by monetary institutions.
This means if things are not quite as rosy as valuations suggest, we will do a good job in defending our client’s capital. We think high yield should still be on your radar.
