Are junk bonds a “new safe haven” for investors?
That question comes from Oleg Melentyev, an analyst at Bank of America Merrill Lynch, who wrote a note last week in an effort to explain the resilience of high-yield corporate debt, or junk bonds, in a turbulent year for financial markets.
Granted, it might sound odd toto refer to junk bonds as a haven given their association with excessive leverage and an increased danger of default, not the port-in-a-storm attributes embodied by U.S. Treasurys TMUBMUSD10Y, -0.47% or the Japanese yen USDJPY, +0.11%
But Melentyev isn’t saying investors have scurried into high-yield, corporate bonds which sport a below investment-grade credit rating, to shelter from market volatility. Rather, he’s explaining why the asset class has managed to outperform other portions of the credit market.
“The high yield market has taken on a new role this year, which is being a relatively quiet haven in an environment where many other key asset classes…have experienced at least temporary, if not more substantial repricing,” wrote Melentyev, head of high-yield credit strategy at BAML, in a note published last Friday.
U.S. high-yield debt is up 1.8% this year. Its performance may pale to the go-go returns of SPX, +0.29% but junk bonds have managed to evade the turmoil that has ravaged emerging markets and even investment-grade paper, its more creditworthy peer. High-grade corporate bonds are down 2.4%, and dollar-denominated emerging market sovereign debt lost 5%, according to data from CreditSights.
The extra yield demanded by investors for buying high yield debt over safer Treasurys stands at 3.48%, four basis points below where it started at the beginning of the year, according to the benchmark ICE BAML bond indexes. A narrower yield premium can reflect investors have an increased appetite for junk debt.
Melentyev says the outperformance stems from three reasons: tax cuts, diminished supply and a gentle pace of monetary tightening.
Tax cuts signed into law by President Donald Trump have lifted corporate earnings, improving the ability of highly leveraged firms to handle the hefty debt loads on their balance sheets. The most indebted quartile of high-yield issuers have seen a sharp decline of the ratio between their debt and pretax earnings to 7.8 times in June from 8.4 times in last December.
Coupled with a favorable supply and demand setup, high-yield bond prices have enjoyed...