The month of June closed with the same negative trends as last month, the sell-off continues without discriminating the fundamental values of the various risk assets, unlike the great falls of recent times (2008 and August 2011). If we focus on the high yield market, we notice a high correlation between the different ratings regardless of credit rating, which indicates that this is not a fall based on credit fears (systemic and increased default), as it was in the above dates.
If we look at the performance of different debt assets from May 9th to June 24th of this year, we can draw the following conclusions:
1. High yield fell lessthan U.S. Treasury bonds and than “investment grade” bonds, which highlights the importance of the spread and the coupon in negative periods.
2. Bonds with a BB, B and CCC rating fell almost the same. This confirms that the sell-off is not due to credit concerns. The credit fundamentals in the high yield market are still very solid. The vast majority of companies already refinanced their debt at long maturities, are at record cash-flow highs and default probability is low (according to JP Morgan about 2%). So the correction is purely technical and not fundamental.
3. The high yield ETF has fallen much more than the high-yield market, nearly 2% of "underperformance" for its trading at premium / discount to NAV and for its tendency to replicate very liquid bond indices.
4. As was to be expected in this correction, those which have performed better are the loans and the short-term bonds. In June, the Muzinich Short Duration Fund fell -1.33%, while that of loans only fell -0.38, versus the high-yield market which in the same period fell -3.6%. The Muzinich America Yield improved its benchmark result with -3.4% during the same period, as is usual in periods of correction due to Muzinich’s management type (without derivatives, without finance and BB and B only).
Having said that, we can see good BB and B bonds in today’s market paying 6 to 7%; levels which are equivalent to those of the summer of 2012 (Northern Hemisphere). So the spreads are already at their 450-550 historical average, but with the difference that the expected default is now much lower than the historical (2% versus the historic 4.5%).
At Capital Strategies Partners, we believe that periods of "non-core" off-risk behavior, as we are seeing right now, represent good opportunities to acquire interesting carry assets. Of course, always under the guidance of a conservative manager who knows how to manage the portfolio’s default efficiently. It’s worth remembering that Muzinich has an impressive track record of default, with only 0.20% of default in more than 10 years, well below the industry’s average rate of 4.3%.
We specifically believe that, currently, the best way to have exposure to high yield is through short-term funds or floating rate funds.
Opinion column by Armando Vidal, CFA, Associate at Capital Strategies.