Unlike equities or commodities, credit investments are not a leveraged play on economic expansion. They do not necessarily need strong growth to deliver their full potential.
Sterling High Yield bond sector returns over 3-yrs
Source: Financial Express Analytics
Empirical evidence suggests that we could continue to see attractive returns from high yield bonds in a low-for-longer growth environment - returns from high yield bonds have historically been highest - 16.5 per cent p.a. on average - during periods of 0 per cent to 2.5 per cent GDP growth, compared to single digit returns during times of faster economic expansion.
Valuations are also still compelling. Current credit spreads of close to 600 basis points are twice as high as during past economic recoveries and significantly overcompensate for potential net losses from issuer defaults.
Default rates are expected to fall from the current level of 4 per cent to just 2 per cent over the next 12 months, and this compares to default rates of close to 13 per cent only a year ago. In addition, credit ratings of high yield companies are being upgraded at a ratio of 2:1, the highest level since the mid-1990s.
We expect high yield corporate bonds to continue to produce double digit annual returns as a result of tightening credit spreads, reasonably stable benchmark yields and low default rates.
Buying of high yield bonds over the past 18 months has mainly come from non-leveraged, long-only strategic investors, which combined with reduced refinancing needs and bond issuance by companies, should provide a very solid technical market backdrop.
Ralph Gasser is senior product specialist fixed income for Swiss & Global Asset Management. The views expressed here are his own