Carry On: Income Opportunities in High Yield Bonds
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Article Type
BondTalk
Topics
Opinion, High Yield
Published
June 03, 2024
Read time
3 mins
Authors
Thomas Hanson, CFA
Mark Benbow
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For income-oriented investors, now is the time for bonds. As rates have shifted higher, coupon rates on newly issued bonds have continued to climb higher, offering income opportunities rarely seen in recent years. Notably, we think high yield bonds are worth a closer look as they provide high income and compelling total return potential. 


Turning point ahead: High cash rates will fade, look to bonds 

With expectations for central banks to cut rates in the future, we are reminded that elevated cash rates won’t last forever. While cash and money market funds provided steady income in recent years, continuing to hold cash will eventually prove to be costly as money market rates reset lower. We believe it is time to consider re-allocating from cash to fixed income. We believe that now is the time to seize opportunities in the bond market to add income and pursue enhanced total returns.


Carry on: Harvesting income in high yield bonds

When it comes to high yield bonds, some investors have been hesitant to add exposure given tight spread levels and concerns about price volatility amid macro uncertainty. However, we mustn’t underestimate the power of carry. After all, the total return for bonds consists of income (coupons) and price (capital) returns. Although price movements are a component, income has been the largest driver of fixed income total returns over the long term (Exhibit 1). The income, or carry, from coupons can provide a buffer against price movements. While prices can be volatile, income provides a steady constant over time.

 

Exhibit 1: Income is primary driver of returns in the high yield market 

Source: Bloomberg, ICE BofA. As of 31 March 2024. Reflects the cumulative price and income return for the ICE BofA Global High Yield Constrained (HW0C) index. Past performance is not a guide to future performance.


Opportunities now: Locking in high income in higher-quality bonds

As rates have shifted higher, newly issued bonds have come to market with higher coupons. However, it is not just the riskiest high yield bonds that offer attractive coupon rates. Rather than stretching for unnecessary risk in CCCs and below, we are uncovering high income opportunities across the ratings spectrum. For example, many BB or B-rated bonds offer double-digit coupon rates, and can provide a sweet spot for investors from a risk/return perspective. Companies in this space can still afford to pay higher coupon rates, but are also better set up to weather a potential economic slowdown. In our view, this is an opportune time to lock in high coupons in higher-quality bonds and add steady income.

 

Exhibit 2: Examples of portfolio holdings with high coupon rates

Source: Bloomberg and ICE BofA. As of 30 April 2024. 

 

Don’t underestimate the power of carry

As economic headwinds persist and high yield credit spreads remain tight, it is understandable why some investors might be cautious on high yield bonds. While spreads could widen, don’t underestimate the power of carry. After all, income is the dominant driver of returns over the long term. In addition, as the saying goes, it is time in the market, not timing the market that matters. For income-oriented investors, now is the time to consider bonds.

Disclaimer

Authors

Thomas Hanson, CFA
Head of Europe high yield

Thomas Hanson, head of European high yield, is a member of the global leveraged finance team. 

Mark Benbow
Portfolio Manager

Mark Benbow, portfolio manager, is a member of the global leveraged finance team. He specialises in high yield bonds and co-manages our global high yield strategies. 

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