Amid aggressive monetary tightening, the short duration profile of high yield bonds can help defend against rising rates.
Short-dated high yield bonds can offer enhanced yield, lower duration and higher risk-adjusted returns.
In the current environment, short-dated high yield bonds present interesting investment opportunities as they offer over 90% of the yield of the overall high yield market with about half the typical duration risk.
Aa lot High Yield Bond research is happening behind the scenes
High Yield is currently being researched intensely. Versus Global Government Bonds or Investment Grade Credit the yield on High Yield Bonds is high. But that investment argument is too simple. Here's what potential High Yield Bond investors are researching:
Are High Yield Bond Markets Cheap?
To answer this question, investors are comparing views on default rates, recovery rates to calculate their expected loss versus the current spread. Only then can they decide whether high yield bond markets are cheap, or not cheap enough. This exercise is also being performed for U.S., Europe and Emerging Market High Yield Bonds. What is interesting is that expected default rates vary widely across high yield bond investment managers.
What Is the Expected High Yield Bond Default Rate?
The variation in expected high yield bond default rates is being driven by two factors: Firstly, investment managers views inside RFPnetworks differ widely on the global economic outlook - growth, interest rates and inflation forecasts. The resultant assumed economic base cases cover a wide range of scenarios. From a shallow recession to prolonged stagflation. And this varies again on a global and regional level (U.S. versus Europe versus Emerging Market economic outlooks).
The second related issue is whether the relatively strong fundamentals can be sustained. Corporate EBITDA is under pressure from rising rates, a strong dollar, rising input costs (e.g. tight labour markets) and the prospect of renewed supply chain constraints as Chinas buckles down on COVID again. So whilst EBITDA estimates have been revised down, the question is whether this is the start of some serial correlation. We've had the first downward revisions, but may be not the last.
Are Short Duration High Yield Bonds The Best Option Today?
The research in this area is getting interesting. Investors are focussing on three characteristics of the short duration high yield bond market: Firstly, they are comparing yield levels on short duration bonds products to the broader high yield and investment grade bond market. And given the wide variation in economic outlooks across investment managers, they are analysing how short duration bonds perform in rising flat and falling rate scenarios. And then looking at the risk adjusted returns of short duration bonds versus the broader high yield market.
Short Duration Bond may look relatively attractive. But before a decision to invest gets a sign-off, a lot of research is happening behind the scenes with potential high yield investors. And only then does the real research begin. How do you find the best high yield investment manager for the current market environment and the diverse future economic scenarios that can happen.
High Yield Bonds
Old Skool High Yield Bonds Outperform Loans
High Yield Bonds have outperformed loans over the past months. But also over the much longer term. And whilst loans and private credit may be the coolest asset class in town, investors are sobering up to a world in which plain vanilla investments and liquidity have old school attractions.