315 billion reasons to like high yield bonds?

According to Fidelity International, roughly $215 billion of US debt and €100 billion of European debt is expected to be downgraded from investment grade to high yield this year.

Companies that move from investment grade corporate bond status to high yield status are known as ‘fallen angels’. And the numbers are so high because the coronavirus crisis and global shutdown have led to concerns that companies with less strong balance sheets and more precarious finances will be unable to pay their bills as people stay at home to avoid spreading the virus.

Opportunity in numbers?

While investment grade corporate bonds are said to be the bargain of the century, can the same be said for high yield bonds?

M&G – whose Optimal Income, Corporate Bond, Strategic Corporate Bond and Global Macro Bond funds are Elite Rated – says high yield bonds are thought to offer the same kind of opportunities as investment grade, but obviously come with higher risk.

Default rates (companies not paying back their loans) were low coming into the crisis but with a recession ahead, these numbers are likely to rise. Some companies will need to restructure their debts and, in some cases, will go bankrupt.

However, there is likely to be dispersion between sectors. For example, M&G believes there is little doubt we will see a very large and substantial uptick in energy company defaults given the oil price wars and the subsequent oil price crash.

Other sectors that look particularly vulnerable are transportation, non-food retail, automotive, basic industries and consumer cyclicals.

But, on the other hand, food retailers, packaging businesses, technology, media and telecom companies, pharmaceuticals and healthcare operators (which are all big parts of the high yield market) will either see relatively limited impact to their businesses or in fact an upturn.

Find out more about FundCalibre’s two Elite Rated funds in this sector: Aviva Investors High Yield Bond and Baillie Gifford High Yield Bond.

Central banks step in

The other potentially helpful factor for the high yield market is that the US central bank, the Federal Reserve (Fed), has said that it will extend its bond purchasing programme to some fallen angels – including Ford and Macy’s, two high profile fallen angels in recent weeks – effectively putting a floor under the market.

The Fed doesn’t have the credit research capability to decide which individual bond it should buy, so it is buying ETFs instead [an index of high yield bond funds].

One commentator said that: “It won’t stop companies from defaulting, but at least this helps high-yield companies manage borrowing costs while they fight to stay in business.”

Income opportunities

Artemis Corporate Bond fund manager Stephen Snowdon also made the point that with dividend yields on equities under pressure and companies deferring or cancelling them in many cases, a lot of investors will need to turn to bonds to replace their lost income.

“And in this world starved of income there are potentially big opportunities in high yield,” he said. “There is some concern over fallen angels, but you can’t really be positive about equities and not positive about high yield [as the two are reasonably well correlated].”

TwentyFour Dynamic Bond managers added a word of caution: “While there may be some single securities in the European high yield corporate universe that appear good value to investors, we will remain patient on the sector while this most tricky part of the cycle plays out and the lower grade companies go through its life-threatening phase.”