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Summary

  • There have been recent headlines about yields in the high-yield market hitting all-time lows.
  • Yields are merely one metric to look at as you evaluate "value" in the high-yield market.
  • Can spreads tighten further, despite the all-time low yields?

By: Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (NYSEARCA:HYLD)

There have been recent headlines about yields in the high-yield market hitting all-time lows. Yes, this is true, but let's put this in some context. First, interest rates have been at or near all-time lows for years, pressuring yields in all fixed income securities as investors search for places to generate returns. Comparatively, we believe the high-yield market still looks very attractive.1

Second, yields are merely one metric to look at as you evaluate "value" in the high-yield market. We believe, especially in this low-yield environment, that spreads (or the difference in yield between the yield-to-worst on the high-yield market and comparable maturity Treasuries) is a better way to monitor levels in the high-yield market. So, let's take a look at historical spreads:2

(click to enlarge)

One thing to note in looking at the chart above is that there are several spikes in spreads that upwardly skew the average numbers. If you look at the data and remove these "systemic shocks" (the periods from 9/30/89 -12/31/91, 5/31/2000-6/30/03, and 6/30/08-11/30/09), the average spread-to-worst goes from 585bps to 487bps, and the median spread moves from 521bps to 468bps. It's also important to realize that nearly two-thirds of the time over the entire 28 year-plus period, spreads have been under the 600bps level. The all-time lows on spreads was 271bps, set in 2007, and we have also spent a good chunk of time at spreads sub-400bps over history.3 So, as we sit today at spreads of right around 400 bps, we are certainly far off all-time lows here. It should also be noted that the spread between investment-grade and high-yield bonds stands at 312bps, also well off the all-time low of 176bps.4

This begs the question, can spreads tighten further, despite the all-time low yields? We believe so, for a number of reasons. First, we expect the demand for yield and fixed income products is in the early phases, as demographics will become more of a factor in the years to come, which we expect to keep rates low and continue to drive investors to yield-bearing products, including the high-yield market. Second, there remains a strong fundamental backdrop to the high-yield market. Leverage levels for high-yield companies remain relatively stable. Total leverage ratios of 4.10x are just slightly higher than the cycle-low of 3.87x seen in the third quarter of 2012.5 Net leverage is even more moderate, at 3.5x.6 Additionally, default rates currently stand at 0.73%7 (excluding TXU), versus a historical average of about 4%, and are projected to remain below average for the next couple of years.8

We believe that there is still value to be had for investors in today's high-yield market. For more detail behind the yield values for the indexes and the negative convexity issue that hampers the high-yield index-based, passive products that don't have the ability/mandate to sell securities, see our article, "The True Opportunity In Today's High-Yield Market." We believe that the value in today's market is there for active managers who can parse through the best opportunities for investment in the space and who have the ability to sell securities that trade at large premiums to call prices.

1Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (Source: Barclays Capital). U.S. 5- and 10-Year Treasury Note is sourced from the U.S. Department of Treasury, Daily Treasury Curve Rates. Barclays Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (Source: Barclays Capital). Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (Source: Barclays Capital). All data as of 5/31/14 for all indexes, except data as of 6/2 for the U.S. 5- and 10-Year Treasury.
2Data sourced from Credit Suisse, as of 5/31/14. Historical spread data covers the period from 1/31/1986 to 5/31/2014. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high-yield debt market.
3Analysis based upon scenario testing of the spread data from 1/31/1986 to 5/31/14 for the Credit Suisse High Yield Index.
4Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. "Credit Strategy Weekly Update." J.P. Morgan, North American High Yield and Leveraged Loan Research, May 22, 2014, p. 5-6. Data as of May 21, 2014.
5Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. "Credit Strategy Weekly Update." J.P. Morgan, North American High Yield and Leveraged Loan Research, June 6, 2014, p. 13. Total leverage ratios as of Q1 2014.
6Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. "Credit Strategy Weekly Update." J.P. Morgan, North American High Yield and Leveraged Loan Research, June 6, 2014, p. 13. Net leverage ratios as of Q1 2014.
7Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. "Credit Strategy Weekly Update." J.P. Morgan, North American High Yield and Leveraged Loan Research, June 13, 2014, p. 46. Default rates exclude TXU, which, due to its disproportionate size, skews the numbers. The current default rate including TXU is 2.08%.

8Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li. "High-Yield Default Monitor." J.P. Morgan, North American High Yield and Leveraged Loan Research, June 2, 2014, p. 5.

Source: A Perspective On High-Yield Spreads

Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contain within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. To learn more about the risks with actively managed ETFs visit our website AdvisorShares.com.