Low Yield Equals Low Return? Not for High Yield 'Rising Stars'

Includes: F, PXD
by: Bondsquawk, CFA

By Rom Badilla

In our post, Secrets of High Yield Fund Managers Revealed, we showed that managers attempted to find Junk bonds that, irrespective of the yield, may be upgraded because of the high potential for price appreciation. As prospects for these bonds improve, these "rising stars" may rise in price as yields decline to match those of their soon-to-be peers in the Investment Grade space.

In their latest Citi Credit Research - It's a Credit Picker's Market Apparently, Strategists, Stephen Antczak and Jung Lee provide a list of bonds that fall in this category.

First, in Figure 12, we highlight "rising star" candidates. These are names that we believe have a reasonable chance of earning IG ratings, do not trade prohibitively tight relative to the average double-B yield (average yield of 4.5% vs. 4.9%), and offer attractive upside potential. If these issues were to trade inline with the typical triple-B issue we calculate that price appreciation could be 6.5% on average.

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The focus of picking bonds likely to be upgraded, aka "rising stars", comes down to the potential change in yield rather than the absolute level, which in many cases were below the yield of the benchmark.

With respect to the yield give-up of ADD CANDIDATES, note that Ford and PXD traded 0.8% and 1.1% through the yield of the double-B index at the beginning of the year, respectively (Figure 11). As mentioned earlier, they still managed to outperform. Again, low yield does not necessarily mean low return, in our view.

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