Update: High Yield & Senior Secured Bonds

How are the rise in U.S. 10-year treasury yields and inflation concerns affecting the high yield bond market?

Broadly speaking, the high yield bond market has lower interest rate sensitivity than some other fixed income asset classes due to its shorter duration. As evidence of this, the historical correlation between high yield bonds and U.S. treasury bonds has been low or, at times, negative. It is also worth pointing out that periods of rising interest rates are often associated with higher growth and inflation expectations. This type of reflationary environment has historically been positive for high yield bonds, and can be conducive to spread tightening and positive performance for the asset class.
 

How have issuers in the high yield market fared since the onset of the pandemic?  Are there any sectors in particular that look compelling today?

Following the severe market sell-off in March 2020, we have seen a strong recovery across financial markets and asset prices—and this momentum gained traction following the positive news flow around vaccine developments toward the end of last year. While various businesses continue to remain hampered from lockdown and/or supply chain-related disruptions, the supportive monetary policy actions by central banks, along with sizeable fiscal stimulus measures by governments, have provided much needed support to the global economy. Issuers in the high yield market have also been able to borrow money to refinance near-term debt obligations and shore up their liquidity profiles, providing breathing room to manage COVID-19 related disruptions in the short term. 

Looking at the market today, from a relative value perspective, we are constructive on the pro-cyclical travel and leisure sector, as we believe valuations remain attractive. In our opinion, the sector also looks well-positioned to benefit from fiscal stimulus measures across developed markets—as they continue to support consumer spending—and may see upside growth potential as economies start to open up again.
 

Given the current environment, do you see more value in senior secured bonds versus high yield bonds?

The two markets present slightly different investment opportunities, as well as offering some material differences in the underlying investible universe. Global senior secured bonds have a sizeable exposure to European markets, for instance, while the unsecured high yield market tends to have a much higher allocation to the U.S. From a sector standpoint, global senior secured bonds have greater exposure to sectors like travel and leisure, while the broader high yield market has more exposure to sectors like energy. 

Global senior secured bonds also have a slightly lower duration profile, which means they are less sensitive to moves in interest rates. At the same time, senior secured bonds reside at the top of a company’s capital structure, ranking ahead of subordinated debt and equity. They are also backed by issuer collateral or some form of assets, which can range from real estate and equipment to intangible items like software and trademarks. Ultimately, this means that if a company defaults on its debt obligation, senior secured bondholders are prioritized in the payment structure and repaid ahead of junior debtholders.
 

Going forward, what are the biggest risks facing the high yield and senior secured bond markets?

With regard to the pandemic, one risk to monitor closely is around the efficacy of vaccines—particularly with regard to new variants and mutations—as well as the deployment and administration of vaccines globally. While markets like the U.S., U.K. and parts of the Middle East have made significant strides in terms of vaccinating their populations, other regions continue to lag, which can impact how quickly their economies are able to re-open.

The ongoing asset price recovery will also be predicated on continued supportive measures from global policy makers. For instance, a premature withdrawal of liquidity from financial markets via tightening monetary policy actions could have an adverse impact on markets. A materially higher move in longer-term interest rates and inflation expectations could also cause heighted volatility. However, as mentioned above, high yield bonds tend to have low interest rate sensitivity. Therefore, as long as the move higher in rates and inflation expectations is manageable—and a result of positive growth expectations—we believe the environment for high yield bonds should continue to be favorable.