The US economy has shown remarkable resilience to higher interest rates; the recession and accompanying plunge in corporate profits that many were forecasting have not occurred. The widely held view of a “hard landing” has given way to a consensus of “soft landing” and, more recently, “no landing”.
CCC bonds have outperformed in this environment. Through September 14, 2023, the CCC segment of the ICE BofA US High Yield Index has returned 14.6%, outpacing the broader high yield market return of 7.2%. CCC-rated bonds are on pace for their best year since 2016.
That CCC bonds have outperformed in a strong market is expected. What is surprising, though, is the extent of their outperformance in a non-stressed environment.
As seen in the chart below, CCC bonds are on pace for their best performance relative to BBs in an environment where US High Yield market spreads already began the year less than 500bps:
Figure 1: Calendar Year CCC-BB Return Difference (%) When Starting ICE BofA US HY Index Spread-to-Worst Less Than 500bps
Source: ICE BofA US HY Index, ICE BofA US HY BB Index, ICE BofA US HY CCC & Lower Index. As of September 14, 2023
In our view, the credit outlook for high yield remains strong. The quality of high yield bonds has improved significantly in the past decade. The ICE BofA US High Yield Index is now comprised of 51% BBs (on a par value basis) at the end of 2022, up from 43% at the end of 2011. At the same time, CCCs have declined to 11%. High yield issuers today are generally publicly traded companies - 69%, according to JP Morgan. Even if the US economy heads into a recession, we believe it is unlikely that default rates spike far above historical norms.
However, high yield valuations are less compelling after the strong 2023 rally. The current spread of 403bps is below the historical average of 461bps and toward the middle of the non-panic range of 350-550 (see chart below).
Figure 2: US High Yield Market Spreads
Source: ICE Data.
Index: ICE BofA US High Yield Index
As of August 31, 2023
There are many risks in financial markets today. However, we maintain stable fundamentals and reasonable valuations suggest that US high yield continues to represent a reasonable, lower duration fixed income investment option.
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About Risk: High yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher quality debt securities. These securities can also be subject to greater price volatility.
SOURCE INFORMATION
ICE Data Indices, LLC (“ICE Data”), is used with permission. ICE® is a registered trademark of ICE Data or its affiliates, and BofA® is a registered trademark of Bank of America Corporation licensed by Bank of America Corporation and its affiliates (“BofA”) and may not be used without BofA’s prior written approval. ICE Data, its affiliates and their respective third-party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ice data, its affiliates nor their respective third-party suppliers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third-party suppliers do not sponsor, endorse, or recommend MacKay Shields LLC, or any of its products or services.
CREDIT RATING DISCLOSURES (FOR INDEX)
ICE BofA Credit Ratings
ICE BofA utilizes its own composite scale, similar to those of Moody’s, S&P and Fitch, when publishing a composite rating on an index constituent (eg. BBB3, BBB2, BBB1). Index constituent composite ratings are the simple averages of numerical equivalent values of the ratings from Moody’s, S&P and Fitch. If only two of the designated agencies rate a bond, the composite rating is based on an average of the two. Likewise, if only one of the designated agencies rates a bond, the composite rating is based on that one rating.
COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
The following indices may be referred to in this document:
ICE BofA US High Yield Index
The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch) and an investment grade rated country of risk (based on an average of Moody’s, S&P and Fitch foreign currency long term sovereign debt ratings). In addition, qualifying securities must have at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $100 million. Original issue zero coupon bonds, "global" securities (debt issued simultaneously in the eurobond and U. S. domestic bond markets), 144a securities and pay-in-kind securities, including toggle notes, qualify for inclusion in the Index. Callable perpetual securities qualify provided they are at least one year from the first call date. Fixed-to-floating rate securities also qualify provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. DRD-eligible and defaulted securities are excluded from the Index.
ICE BofA US High Yield BB Index
The ICE BofA High Yield BB Index is a subset of the ICE BofA US High Yield Index including all securities rated between BB1 and BB3.
ICE BofA High Yield CCC & Lower Index
The ICE BofA High Yield CCC & Lower Index is a subset of the ICE BofA US High Yield Index including all securities rated CCC1 or lower
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