Fixed income
High Yield – a fulcrum between greed and fear?
5 min read 13 Feb 23
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Last year was a brutal one for fixed income markets, although floating rate high yield credit was a notable bright spot and proved remarkably resilient. While conventional fixed rate high yield bonds sold off sharply, HY floating rate notes (FRNs) and European and US loans held up well and were able to generate a small positive return over the year.
A key factor driving the relative outperformance of FRNs and leveraged loans over their fixed counterparts in 2022 (see Figure 1) was their lack of interest rate duration – as floating rate instruments, their coupons are automatically adjusted in line with short-term interest rates. They were therefore well insulated from the turbulence in government markets as the Federal Reserve pushed ahead with its rate hiking agenda.
Floating rate HY bonds also benefited from their senior-secured characteristics, which provides them with a strong claim on a company’s assets in a default scenario. As a result, recovery rates tend to be materially higher compared to unsecured bonds.
After years of ultra-low interest rates, we believe HY FRNs currently offer an attractive source of income, which should provide a strong cushion against any further period of market turbulence. Thanks to its lack of interest rate duration and senior-secured properties, HY FRNs demonstrated their resilience in 2022. By providing yield with effectively no interest rate risk, we believe these instruments will continue to serve a useful role within a fixed income portfolio.
Performance review – floating rate vs fixed rate high yield
Past performance is not a guide to future performance
Source: ICE Bank of America Indices, 31 December 2022. Index performance shown 100% hedged to USD. Global HY: ICE BoA Global High Yield Index. Global HY FRN: ICE BofA Global Floating Rate High Yield 3% Constrained (USD Hedged) Index. US HY: ICE BoA US High Yield Index. Europe HY: ICE BoA European High Yield Index. European loans: Credit Suisse Western European Leveraged Loan Index 3 year DM. US loans: Credit Suisse Leveraged Loan Index 3 year DM
