Amid a global economic slowdown due to central bank rate hikes, investors are avoiding high-yield bonds. AllianceBernstein (AB) believes that while the asset class has historically suffered during economic slowdowns, current conditions suggest that a different perspective.

“Today’s high-yield bond issuers are in much better shape financially than issuers entering past slowdowns, thanks in part to the extended period of uncertainty surrounding the coronavirus pandemic…As a result, leverage and coverage ratios, margins, and free cash flow (has) improved,” writes Scott DiMaggio, Co-Head of Fixed Income at AB. 

Additionally, DiMaggio points out that the high-interest coverage ratios seen in today’s market suggest that even if earnings decline significantly or if issuers refinance at current rates, their financial positions will remain robust. According to him, this resilience comes from the prudent fiscal measures taken during the pandemic.

Subsequently, the asset manager contends that pandemic-induced defaults and downgrades have led to a stronger high-yield market with higher average quality due to the removal of weaker companies. This, combined with extended maturity timelines and the influx of higher-rated fallen angels, has resulted in a more secure high-yield universe, added AB. 

“As a result, we expect a moderate default rate for the next 12 to 18 months…What’s more, the share of the high-yield bond market that is secured…is high by historical measures, which may translate into higher recovery rates in the event of default,” informed Gershon M. Distenfeld, Director of Credit at AB. 

However, Distenfeld advises investors to focus on higher-quality credits, exercise selectivity, and consider liquidity, as lower-rated credits are more vulnerable. Subsequently, he opines that another compelling reason to embrace high-yield bonds is the current favourable pricing. 

“Take a longer view—an investment horizon of four or five years, say—and the picture gets even better. History shows that the high-yield sector’s yield to worst has been an excellent proxy for its return over the following five years. In fact, high yield has performed predictably, even through rough markets,” said Matthew Sheridan, Portfolio Manager at AB. 

Furthermore, Sheridan explains that while there is hesitation among some investors regarding high-yield bonds due to concerns about market timing and average spreads, waiting on the sidelines can lead to missed opportunities. 

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