Within the high-yield universe, we expect the dispersion of returns across industries and also across different issuers within an industry to increase over the coming year as investors differentiate between the winners and losers and idiosyncratic risk becomes a greater driver of returns.
Key Risk To Monitor In 2014
Investors will need to keep an eye on valuations to ensure that we continue to be amply compensated for risks incurred. Key risks for the high-yield market are default risk, interest rate risk, event risk and changes in the risk premium. The global high-yield index provides a spread versus duration-matched U.S. Treasurys of more than +360 basis points, which remains well wider than the tights of +225 bps experienced in the spring of 2007, and should be more than ample to cover losses due to defaults. Both interest rate risk and event risk are greater potential threats for investment-grade credit than for high yield. So, as has been the case over the past three years, material changes in high-yield bond spreads will most likely be driven by changes in the risk premium in the coming year as investor risk appetites shift in response to economic data or changes in fiscal or monetary policy.
Periods of volatility can create buying opportunities for investors who are not yet at their target exposure and who seek incremental yield in their portfolio. Any short-term market correction that may unfold in 2014 is unlikely to turn into a protracted bear market because of the macro backdrop. High-yield credit fundamentals remain solid and liquidity profiles are strong since so many companies have already refinanced most 2014 and 2015 debt maturities by extending the terms on bank loans and issuing bonds with maturities in the 2020-2023 range.
Perhaps the biggest threat to the market is the potential for gently rising Treasury yields to morph into a rapid spurt higher, which could become destabilizing for risk assets as happened in Q2 2013. However, inflation remains benign, inflation expectations are unlikely to become unmoored, and the Fed is going to great effort to communicate forward guidance to the market. By issuing forward guidance, the Fed is seeking to keep Treasury yields well tethered through intermediate maturities by indicating no change to the federal funds rate until at least mid-2015, even as it tapers the pace of quantitative easing in 2014. However, investors and financial markets may test the mettle of the Yellen Fed if the economy strengthens and bond market vigilantes drive Treasury yields higher as they fear an overly accommodative Fed sparking inflation.
*The Barclays Global High Yield Corporate 2 percent Issuer Capped Bond Index posted a total return of +8.15% in 2013, outpacing all other fixed-income sectors, and slightly ahead of our own forecast of a 7-7.5 percent return in our publication "2013: A Year in Global High Yield Bonds," which came out last year at this time.
Wesley Sparks is the Head of US Taxable Fixed Income at Schroder Investment Management North America Inc., which he joined in 2000. Wes oversees a team of 18 professionals in the US Fixed Income group in New York. The team manages approximately $11 billion in assets across a number of institutional accounts, including public and private pension funds, Taft-Hartley accounts, insurance companies and mutual funds. Wes was the Head of US Credit Strategies prior to assuming the role of Head of US Taxable Fixed Income in September 2008. As a portfolio manager, Wes’s expertise is in the corporate bond sector. Wes built Schroders' high-yield team over the past five years, and he has been the Lead Fund Manager for Schroder ISF Global High Yield since its inception in April 2004. He is now Lead Manager on a number of other mutual funds, all of which are managed on a team basis.