How’s the high-yield market doing? That’s usually a simple question for credit investors to answer. However, the answer today is contingent on what part of the high-yield market you’re asking about. The market traditionally has had a fairly high correlation among similarly rated credits, but recently we’ve seen a distinct separation between the haves and have-nots. So, how’s the high-yield market doing? That depends. It’s either smooth sailing or exceptionally choppy seas.
Spreads between higher-quality BB rated companies and highly speculative CCC rated companies are a simplistic but relatively accurate measure of how comfortable the high-yield market is with risk.* According to the Bloomberg Barclays US Corporate High Yield Index, that spread was 674 basis points on Sept. 30, which was 88 basis points higher than at the end of June (one basis point is equal to 0.01%). The broad flight to safety was driven largely by weaker economic growth fueled by the U.S.-China trade war, but it only tells one part of the story.
Companies experiencing calm seas not only carry a high rating, but are also U.S.-centric, consumer-driven and not competing with behemoths such as Amazon. Among the new issues that came to market in the third quarter, Restaurant Brands (franchisor of Burger King, Popeyes and other quick-service food companies) brought $750 million of eight-year secured, Ba2 rated bonds at a remarkable yield (income returned on investment) of just 3.875%, less than 1% more than the 10-year Treasury yielded a year earlier. Demand was such that the offering was substantially upsized, and the final yield lowered from the initial price talk.
Navigating rougher waters are companies such as L Brands, which are finding the market much less accommodating. The parent company of Victoria’s Secret and Bath & Body Works is similarly focused on the U.S. consumer, but it has most of its locations in shopping malls that are becoming increasingly irrelevant in the digitally-driven retail market. While L Brands is rated one notch better than Restaurant Brands, similar maturity L Brands bonds yielded close to 7%. For the top 10 holdings of Pacific Global Focused High Yield ETF, click here.
That comparison just scratches the surface of the bifurcation of the high-yield market today. Companies in the energy, retail, chemical, wireline, and other sectors find few bidders, but there is abundant capital for companies in the finance, leisure, media, and consumer services sectors.
Navigating this type of market is challenging, but also provides opportunity. Our focus is now to own a responsible number of the low-risk names while utilizing credit research to select companies offering a significant yield premium and solid long-term value. While we’ve limited our exposure to the energy and retail sectors, we continue to find value in select industrial and restaurant bonds. We also are maintaining a larger-than-normal cash allocation; as we saw at the end of last year, cash in times of poor liquidity can provide exceptional opportunities.
*Company ratings are measured on a scale that generally ranges from AAA (highest quality) to D (lowest quality).
Bob Boyd is a portfolio manager with Pacific Asset Management, sub-advisor to Pacific Global Focused High Yield ETF.