The high-yield bond market should have a good year in 2024 as inflation comes down and boosts risk assets, a fund manager has said.
Jordan Lopez, a portfolio manager at Payden and Rygel, said they expected lots of “macro tailwinds” that would support all risk assets — but particularly high-yield bonds — over the next year.
He also pointed to the makeup of the high-yield market, saying it was “very healthy” with all-in yields at 8 per cent.
“High-yield bonds benefit from growth in general and as inflation comes down, which we believe it will, rates should rally to the benefit of high-yield bonds,” said Lopez.
“In some ways, it’s the best of all worlds. We believe unemployment will remain low, growth will remain positive and inflation will continue to trend down.”
The high-yield bond market is a segment of the corporate bond market, where investors effectively lend money to companies.
Those companies in the high-yield sector have lower credit ratings than their investment-grade counterparts, so the companies are more likely to default.
This makes it a riskier investment, but this is normally rewarded with higher interest payments.
Soft landing
Al Cattermole, portfolio manager at Mirabaud Asset Management, agreed that this expectation of a “soft landing” for the economy — falling inflation matched with central bank rate cuts but with still positive growth — was a “great environment” for high-yield bonds.
However, he was less certain that a “soft landing” would play out.
“The overarching macro narrative has shifted so often and so dramatically over the past two years that conviction is very low across the market – what will be the next big shift?,” said Cattermole.
“The new fear may well be the ‘no landing’, where central banks do not see the need to cut rates and we see a significant re-pricing in government bonds.”
Cattermole said that high-yield bonds could still work for investors in this scenario, though.
While a “no-landing” would pressure high-yield bonds, investors would be helped by a high starting yield buffer, the potential for tighter credit spreads and the recovery in certain industries.
A substantial risk to high-yield bonds is a recession.
Last week (February 15), official figures showed that the UK had entered a recession at the turn of the year after two quarters of negative growth (although most experts expect it to be “shallow”) and some analysts say that the US is likely to follow suit.
A recession can result in increased financial stress on businesses, hurting cash flow and reducing profitability. This increases the risk of default, potentially making high-yield bonds a riskier bet.
Nick Burns, another portfolio manager from Payden and Rygel, argues that many of the companies in the high-yield space were “prepared to manage through a recession”.
He said: “We've seen persistently positive results in terms of issuers continuing to maintain balanced balance sheets and balanced credit metrics, with overall fundamentals that suggest that they are prepared to manage through a recession.”
