High yield bonds are currently offering an attractive entry point and will present further compelling opportunities over the course of 2023, according to Thomas Hanson, head of European high yield at Aegon Asset Management.
With economic uncertainty prevalent as 2023 begins, Hanson says high yield bonds still offer an attractive opportunity to lock-in what has historically been an attractive entry point into the asset class.
“Over the last 10 years there have been very few opportunities to access the market on a yield above 8%,” Hanson says. “Historically, investing when yields were above 8% resulted in above-average total returns.”
“While environments with higher yields were fraught with economic weakness and macro headwinds, the high yield market generated strong rallies that provided opportunities for investors to generate above-average forward returns,” he says. “Since 2008, yields above 8% have historically proved to be attractive entry points. For the months when the starting yield was above 8%, the average forward annualized returns ranged from about 11% to 19% over a one-, three- and five-year basis for the ICE BofA Global High Yield index.
“Although each cycle is different, and the current higher yield is primarily the result of higher rates, yields above 8% have been relatively rare and have historically provided attractive long-term return potential. After many years of low rates, the high yield market currently offers an attractive all-in yield. Additionally, bond prices that are well below par should also provide positive price appreciation potential.”
Hanson says that high yield spreads do not yet definitively point to a recession and could certainly widen further in view of the uncertain economic outlook.
“With spreads around 500 basis points, the market is not fully pricing in a recessionary downswing. Given the elevated expectations for one in 2023, it is likely that the high yield market could be biased toward bouts of spread widening in 2023. However, we think spread widening could be more contained relative to prior downturns given the higher-quality composition of the market and the strong technical is also supportive here
“If the recession is relatively short and shallow, elevated spreads could prove short-lived and be followed by a sharp snapback. These environments have historically created compelling entry points and provided outsized forward returns for investors with a longer time horizon.”
Despite concerns about defaults rising in the high yield market, Hanson believes corporate defaults will remain lower than is typical during recessionary periods. Many high yield companies are entering 2023 with solid fundamentals, and the team believes most companies are well-positioned to navigate a slowdown.
“While defaults trend upward during recessions, we expect them in the next downturn to be more muted” he says. “This view is based on various factors including the healthy fundamental starting point, a higher-quality high yield market, and few near-term maturity concerns.
“Despite a muted defaults outlook, we think caution is warranted in 2023. Challenging economic conditions are setting the stage for an interesting year ahead. Volatility will likely remain elevated as the market grapples with macro headwinds. However, we expect market dislocations will expose intriguing buying opportunities and attractive entry points.”