Attractive Risk/Reward in Short Duration High Yield

October 5, 2023

Source: Bloomberg Source: Bloomberg

As we enter the fourth quarter and look into 2024, the front end of corporate capital structures continues to be one of the best places to be positioned. To me, this offers the best combination of credit and duration risk in the market given current valuations and numerous risks lurking on the horizon. Specifically, high single B/low BB-rated bonds with maturities in the 2025-2027 time frame look to be the sweet spot, as these securities have reasonably good credit quality, high current yield/carry and modest interest rate risk. I would also include BB leveraged loans, which in many cases out-yield their pari-passu secured bond counterparts by approximately 100 basis points (bps) due to the inverted nature of the yield curve. Today’s Chart of the Week shows the yield to worst on the Bloomberg Barclays Global High Yield 1-5 Year Index stands at an attractive 9.0%. 

The consensus forecast now calls for possibly one more rate hike in 2023, followed by an extended pause in which the Federal Reserve will monitor the monthly inflation, employment and growth data. So far, businesses and consumers have been remarkably resilient, but there is a nagging feeling that the more than 500 bps in rate hikes will start to take a toll on spending and sentiment. Near-term maturities should outperform credits with more spread duration in a scenario of weaker economic growth while also outperforming if the economy remains robust and interest rates continue to rise. With capital markets wide open and chief financial officers realizing that rates will be higher-for-longer, front-end bonds may also be the beneficiaries of early calls or tenders.

Key Takeaway

The risk in the front end is to avoid potential restructuring candidates, particularly if the bonds are unsecured, so credit work remains critical regardless of bond tenor. Another important risk with this strategy is continued capital market access since the vast majority of high-yield bonds do not actually mature — they are refinanced. The risk is amplified because front-end bonds typically trade closer to par and thus have high dollar prices, so if something goes wrong, the way down can be painful. Still, should an event cause difficulties in the primary market, many companies have demonstrated the ability to issue secured debt, and the recent rise of large pools of private credit offers another lever to pull for solvent businesses.

Tags: Credit risk | duration risk | Leveraged loans | Interest rates | Capital Markets

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The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

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