Global High Yield: Keep calm and carry on

INDUSTRY VOICE: A gradual normalisation of monetary policy in developed economies against a backdrop of steady global economic growth should continue to be supportive of high yield credit in the medium term. Higher oil prices and rising interest rates have led investors to favour shorter-duration bonds with a cyclical tilt, and to the outperformance of high yield over investment grade bonds. Over the longer term, high yield corporate bonds tend to produce similar returns to equities but with lower volatility.

Since the beginning of the year, global investment grade credit has lost 3.2%, while high yield credit has fallen by just 1%, suggesting that the negative returns were mostly due to the rise of interest rates rather than a decline in credit fundamentals. The high yield segment has generally been resilient in previous Fed tightening cycles, because it is less sensitive to movements in interest rates than investment grade credit. Since the Federal Reserve started to increase the fed funds rate in December 2015, global high yield credit has outperformed investment grade credit.  

Limited capital appreciation but positive carry

The US Treasury yield curve has flattened substantially and credit spreads are tight by historical standards. In particular, global high yield spreads are in the 17th percentile (i.e. spreads have only been tighter 17% of the time since 2000), leaving capital appreciation limited. However, markets are already pricing in three to four rate hikes from the Fed this year, reducing the risk of a sharp yield curve adjustment in the medium term, unless inflation unexpectedly rises significantly above 2%. Furthermore, the total return in high yield bond markets is mostly sourced from coupons, which are considerably higher than those of investment grade credit. Overall, the positive carry (i.e. the coupon rate of the bond index minus the funding rate) should offset the negative price impact from slowly rising interest rates, limiting the risk of a prolonged period of negative returns in the medium term.

Managing your credit exposure using corporate bond ETFs

While global high yield bond ETFs have recorded net outflows of US$5bn year-to-date, they have seen net inflows of US$1.7bn since March, according to Bloomberg data as of 7 June 2018. Our BMO Global High Yield Bond ETF offer investors global exposure to the high yield bond markets. In addition, to be cost-effective, bond ETFs also provide an extra layer of liquidity allowing investors to quickly adapt to the changing economic environment.

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