Global High Yield Bond Market - Nomura Asset Management

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  • 09 mins 01 secs
Michael Dugan, Executive Director and Client Portfolio Manager, Nomura Corporate Research and Asset Management (NCRAM), discusses the Global High Yield Bond Market, high yield valuations, where he sees opportunities, sectors of interest and his positioning outlook for 2018.


Nomura Asset Management
PRESENTER: To discuss the global high yield bond market, I’m joined by Michael Dugan, who’s the Executive Director and Client Portfolio Manager of Nomura Corporate Research and Asset Management. Michael, good to have you with us today.

MICHAEL DUGAN: Great to be here, thank you.

PRESENTER: Right, so let’s start with high yield fundamentals, such as default rates, leverage, quality of earnings, what are you seeing in this area?

MICHAEL DUGAN: We’re seeing low default rates. Default rates right now are about 1.3%, so well below the historical mean of around 4%. It seems like we’re actually past the energy default cycle, so we think most energy companies that were going to default have defaulted. And any stress that’s left in the market is really focused on retail. So a lot of retailers are under pressure from the Amazon effect, but it is a relatively small part of the market. So, if the default rate does raise, which we think it could potential stay between 1½ and 2%, that will mainly come from the retail sector. Aside from that earnings have been somewhat mixed, but generally more positive. And if you look at the GDP growth in the US we’ve had 2.7, 3.1% sequential growth. So it seems like the economy is picking up. Leverage over all is down from its peak back in about mid-2016, so leverage on average for the market is about four times debt to EBITDA, and interest coverage has grind back up to about 3½ times.

PRESENTER: Well looking at the high yield valuations, do these really stack up, and how sustainable would you say they are?

MICHAEL DUGAN: Well we think we’re in a spread constrained environment. So spreads for the market are roughly 370 basis points. We think over the next 12 months that it’ll stay within a range of roughly 350 to 400 basis points. More recently we did have a short selloff. About two weeks ago spreads gapped out to 415, but collapsed back down to 370. So ultimately we think it’s going to be spread constrained, and we think we’ll end the 12-year period pretty much where we are right now at 370 basis points.

PRESENTER: When it comes to duration sensitivity, what do you favour, short duration or?

MICHAEL DUGAN: Yes, right now we’ve had an overlay in the portfolio of looking for higher coupon, shorter duration. So we’re really in the yield to call market with regard to CCC-rated issuance. Our CCC exposure is roughly 10%, but the vast majority of that is yield to call non-cyclical paper; also US focused. But our duration overall for the portfolio is about a half a year short to the index, so we’re roughly at 3; the duration for the high yield market is 3½. So we are underweight duration sensitive securities.

PRESENTER: And why did you choose to do this?

MICHAEL DUGAN: The strategy really started back in 2013. We didn’t think treasury levels were sustainable. The US 10-year treasury was 1.67. At that time that’s when we started looking for these higher coupon, shorter duration type securities, we also went up to roughly 19% in CCC to put more spread cushion in the portfolio, and also due to the negative correlation with the 10-year. So we did outperform during taper tantrum in May and June, and then we also outperformed in August, and that’s when we started to buy some BB paper that had sold off solely on duration.

PRESENTER: So looking at your holdings now, where are you seeing opportunities?

MICHAEL DUGAN: We still see opportunity in the energy sector. So we’re overweight energy, exploration and production, also gas distribution companies. The focus has been on falling angel credits. That’s formerly investment grade credits that are downgraded into high yield. They’re typically much more diverse with regard to revenues and assets. So we’re still finding opportunity there. We’re also finding some opportunity in the banking sector. We have been buying US trust preferreds, which is off benchmark. That’s part of our strategy. And also gaming, gaming is more of a pure play on the US consumer, so we do have exposure to both regional gaming companies and also Las Vegas based gaming companies, and we have been avoiding Atlantic City.

PRESENTER: And what about when it comes to commodity prices, obviously in the oil sector it was low, it picked up a bit. It does tend to be a bit choppy, what are you seeing when it comes to these sort of things?

MICHAEL DUGAN: You know we did obviously have a significant drop in oil prices. I believe the low was back in February last year at about $27 for WTI crude. We since rallied over the past two months, which has been good for our portfolio. So WTI prices are back up around $57. It’s actually above the range of what we thought it would be. We thought at the beginning of the year that WTI would stay within $45 to $55. So now we’re seeing a new range being established. And then with regard to commodities it is a cyclical sector. We are invested in metals and mining companies, in iron ore, copper prices, platinum prices, met coal have all been rallying. So I think that’s indicative of a growing economy and increasing demand on a global basis.

PRESENTER: And any other sectors of interest to you?

MICHAEL DUGAN: You know right now I think those are the main focus. I think another thing about what we’ve been doing is avoiding the retail sector. So we have very little exposure to retail sector; the only area that we do have exposure to are auto part suppliers. We find that those companies have been somewhat insulated from the Amazon impact. But in high yield oftentimes it’s what you don’t own more so than what you do own that drives alpha. So we’re significantly underweight the retail sector.

PRESENTER: And looking at the global high yield market, I mean you touch on the US, but I mean what are seeing, where are you seeing the opportunities globally, Europe, that sort of thing?

MICHAEL DUGAN: Sure, well just to give you a little bit of backdrop, we’ve been managing US high yield since 1991, so just over 25 years. We launched our European high yield capability back in 2012, and we launched global high yield back in 2013. The current posturing of the portfolio is slightly overweight the US. Again that’s basically our outlook for US growth. We think it’s more positive now. We also think that valuations are more skewed to US. You have absolute yields in US high yield of about 6%; in Europe it’s about 2½%. So there’s a yield pickup between the two. But the European economy is improving. So globally we think that demand is picking up overall, demand for commodities, demand for WTI crude, and economic growth seems to be stabilising but also increasing. So we do have a tilt more towards US high yield, but we are very active in European high yield. And within European high yield we are underweight banking and financials. That’s just a general tilt of the portfolio. Also a similar tilt with credit quality, we’re underweight BBs, overweight Bs, and the CCC market is small in European high yield. There tends to be a higher quality asset class, but we are slightly overweight CCCs as well.

PRESENTER: So then how are you positioned versus credit tiers?

MICHAEL DUGAN: So the posture of the portfolio right now is underweight BBs. The reason for that is relative value, but also that’s the most duration sensitive part of our market. So we’re underweight BBs. Overweight B+. That tends to be where our strategy falls out. It’s not a structural issue, but our credit selection typically leads us to that area of the market. And then we’re also overweight CCCs. CCC+, mainly short duration, yield to call paper. It’s more of a play on the overall economy. So we think the economy is improving, Bs and BBs are much more correlated with the underlying economy more so than movements in the treasury market.

PRESENTER: Well the New Year is just around the corner, so what’s your outlook and positioning moving forwards?

MICHAEL DUGAN: So our outlook for high yield over the next 12 months going into 2018 is basically yield-driven returns. So we think returns will be in the 5 to 6% context. We think that you will see very little in the way of price appreciation. Spreads constrained, and in 2018 roughly where we are right now. Yields are just south of 6%. We think that’s still attractive on an absolute basis. So going into the New Year we’re still going to carry our overweight to energy, exploration and production, gas distribution, gaming, and then the overall tilt of the portfolio still more skewed to Bs and a slight overweight to CCCs.

PRESENTER: Super, Michael, thank you.

MICHAEL DUGAN: Great, thank you.