I see increasing volatility in financial markets in coming months as the world becomes increasingly recessionary. Many companies are going to face tougher trading and financing conditions. Defaults are going to rise.

So you might expect me to be pessimistic about the outlook for high yield credit. I am not at all. I see good opportunities because yields are high on a historic basis. That means that investors are being adequately compensated for the risk they take. If you are an active investment manager who is cognizant of these risks and able to use careful credit analysis to avoid highly stressed parts of the market, there is potential for attractive returns, in my view.

Global high yield market

Yield to maturity in perspective

Global high yield market: historical yield to maturity and coupon, last 10 years
High yield market
Source: Bloomberg. Global HY Index: ICE BoFA Global high Yield Constrained Index, as at 31.10.23.
There is a looming 2025-26 debt maturity “wall,’’ which will be a big feature of the market in 2024, however. Many companies that have debt maturing are going to struggle. If they refinance it will be at higher rates — in some cases significantly higher.

The chart above shows the significant gap between the average coupon and the average yield to maturity that a company would face refinancing in the current market. Some companies may struggle with a combination of higher funding costs and deteriorating performance as the economy weakens and profitability softens. It may require internal self-help actions such as cutting capex and dividends, or an external boost from asset disposals or equity injection. Investors must anticipate how refinancing risks will play out — we are already seeing companies today that are restructuring to address maturities due as late as 2027. I would expect companies that over levered their balance sheets when rates were low to face difficulty, distress and, in some cases, default. For high yield investors, this makes credit selection even more important.

Maturity wall

Prevailing yields pose a challenge for 2024/25


Global high yield market: maturity wall

Bar chart
Source: Bloomberg. Global HY Index: ICE BoFA Global high Yield Constrained Index, as at 31.10.23.
Credit spreads in high yield were relatively tight in 2023, suggesting investors were possibly complacent about the impact of central bank rate hikes, preferring to buy into the “soft landing” narrative that has been prevalent for most of the year. That’s starting to change. Spreads in CCC bonds have begun to blow out, and that indicates the market is finally starting to worry about those companies which seem to face insurmountable refinancing problems.

I am extremely cautious about owning consumer discretionary and industrial companies given where we are in the economic cycle. I also am bearish on telecoms companies as telecoms tends to be an over-levered sector with limited growth potential and heavy capex requirements.

Although our macro perspective is cautious, we are happy to go long on risk that we think is cheaply priced. We also think it prudent to focus on liquidity within a high yield portfolio; it makes sense to have defensive ballast in the form of higher cash levels because the market hasn’t bottomed yet.

Commentators talk about the “high yield market,” but for active investors the market is a melting pot of thousands of businesses with individual strengths and weaknesses.  With careful credit selection, it’s now possible to own a portfolio of high yield bonds that offer double-digit yields and adequately price the risk of a deteriorating macro environment. Yield is always the safety cushion in fixed income, and the higher yields that we now see in areas of the high yield bond market offer the potential for strong future returns as well as cushioning against the volatility we may see in 2024.

Robust credit analysis will be crucial.  It will be important to look at individual companies, analysing closely how they can perform in what may be a tricky 12-18 months for the global economy. Weaker businesses with too much short-term debt may go to the wall.  Yet, yields are now at a point where I believe you can make good risk-adjusted returns. Our approach, as always, is to be “active, pragmatic and risk aware.’’ Realistic, but not pessimistic.

The value of active minds: independent thinking

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