Highlights from high-yield credit

From rising trade tensions to falling oil prices, 2018 provided investors with plenty of volatility.

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As investors head into 2019, “it’s important to review how we got to where we are now,” says Nicholas Leach, vice-president of global fixed income at CIBC Asset Management. He manages the Renaissance High-Yield Bond Fund.

One significant impact on fixed income in 2018 was rising interest rates.

In the first three quarters of 2018, “the 10-year Treasury yield rose from 2.4% to 3.2% by October—that’s a huge move,” Leach said in a Dec. 6 interview. The Canadian 10-year bond also moved higher during that period, from 2.1% to 2.6%.

Rising yields are “obviously bad for bondholders,” Leach said. To Q3, the broad U.S. bond market was down about 2.1% for investment-grade corporates and about 3.7% for the 10-year Treasury, he said.

In contrast, U.S. high-yield was up 2.5%, with a similar scenario in Canada. While the Canadian broad market was down 50 basis points, “Canadian investment-grade corporates managed to just tweak out a 14-basis-points positive return,” Leach said.

“Corporate credit always outperforms in a rising interest rate environment,” he said, because the higher coupon carry and spread compression provide cushion against rising rates, “and 2018 was no exception.”

In the fourth quarter, market sentiment turned. U.S. equities fell by about 13% and the volatility index spiked, driven by such things as trade tensions, Brexit uncertainty and falling oil prices.

“Credit spreads always widen in this type of risk-off environment, both for high-yield and investment-grade,” Leach said.

He also noted the role of technical indicators. For example, last September and October, retail mutual funds saw billions of dollars in outflows, while money market funds saw corresponding inflows. The latter funds are attractive because of the flat yield curve, Leach said. “Investors can pick up extra yield and not take on as much interest-rate risk.”

As a result of the bond sell-off, spreads widened, but “we’re not seeing a fundamental deterioration in credit quality,” said Leach, who sees the shift in asset mix from longer-term corporate bonds into money market funds as a transitional phase.

Lastly, the bond market exhibited idiosyncratic risk in 2018 among some large bellwether U.S. investment-grade issuers, Leach said, with such names as General Electric and Ford selling off.

Overall, the volatility in the broader credit markets provided “some pretty good opportunities,” he said. For example, Ford senior unsecured bonds spiked into high-yield territory due to fears of a ratings downgrade. “Spreads were actually 50 basis points wider than its competitor, Ally Financial,” says Leach. “Those were subordinated bonds, so it was really overdone.”

He also reduced exposure in some of the higher-beta energy companies, where credit spreads lagged the drop in oil prices. The reduction was “good timing,” Leach said, “because the credit spread on some of those energy companies did catch up to the falling oil prices.”

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