When you think about it from a risk-adjusted basis, we think the yields in high-yield look attractive to us – based on the significant shift that we’ve seen in credit quality.
Attractive yields across below-investment-grade credit
When I think about below-investment-grade assets today, I think the yields look very attractive relative to history, as well as other asset classes. When you look at the chart in terms of yields today, you can see that they offer very attractive absolute yields, which should turn into returns over the next 12 months.
The other thing that I think about in this chart is just the durability of these yields. We expect these yields to stay around these levels at least for the next 12 to 18 months. We are expecting base rates to be at least at this level, if not higher, going forward, and that should provide some real durability, particularly to the floating-rate asset classes like CLOs and bank loans.
How the Below-Investment-Grade Market Has Changed
The biggest change over the past 15 years for the below-investment-grade market is that the high-yield market has shrunk, while the private debt and private credit market has grown substantially. As you can see from the chart, we’ve seen a significant increase in private credit, followed by a more modest increase in CLOs and bank loans – all at the expense of the high-yield market.
A Higher-Quality High-Yield Market
What that has meant for high yield is it’s turned into a much more high-quality market. BBs now represent 55% of the overall index, secured issuance is at an all-time high at 35%, and duration’s at an all-time low inside of four years.
CLOs and Bank Loans Move Mainstream
The CLO and bank loan asset classes, I’d say they’ve moved more from niche asset classes to things that are more mainstream today. We’re seeing much more institutional interest in bank loans and CLOs. As those markets have grown, they become more liquid, more mature, and with a more diverse investor base. That’s really just a long-term positive for investors.
Credit Risk Remains the Primary Risk
The number one risk that investors need to be focused on for below-investment-grade issuers is credit risk. Currently, our view is that fundamentals are quite strong. We’re seeing good growth across a number of different sectors within the U.S. economy.
That strength then is leading to a default rate that we think will be in line with the long-term average, so in that 2% to 3% range. With that type of backdrop, that’s a quite healthy environment for non-investment-grade investments and yields being durable and stable.
Short Duration Helps Mitigate Interest-Rate Risk
The other thing that we think about would be interest-rate risk. That’s one of the big concerns for most fixed-income investors. Again, the benefit for non-investment-grade assets is the relatively short duration. Again, high yield has a duration of inside of four. Of course, the CLO and bank loan investments are floating rates. Therefore, a very short duration. That interest-rate risk that is forefront on many investors’ minds, we think is fairly well mitigated in the below-investment-grade space today.
Decision Points is a new video series that looks at the data driving fixed income markets. Bringing together views across Neuberger’s Fixed Income Team, these perspectives offer a closer look at the opportunity set across public and private markets.
In episode 3, Joe Lynch, Global Head of Non-Investment Grade Credit, looks at what’s behind today’s attractive yields and how the below-investment-grade market has changed over the past 15 years. He discusses why he believes those yields may remain durable and why credit risk continues to be the key risk for investors.
Three key takeaways
- We expect below-investment-grade yields to remain attractive over the next 12 to 18 months, with base rates helping support their durability.
- High yield now represents a smaller share of the below-investment-grade market than it did 15 years ago, while the high-yield market itself has become higher quality.
- Credit risk remains the primary risk in below-investment-grade credit, while relatively short duration helps limit exposure to interest-rate risk.
