Investors shun high-yield bonds on recession, banking risks

SEI Investments

16/03/2023 11:35

By Patturaja  Murugaboopathy  and Davide Barbuscia
       March 16 (Reuters) - Global investors have resumed their
selling of high-yield corporate bonds after a brief respite in
January, as fears over the health of smaller banks add to risk
aversion driven by worries over rising interest rates, recession
and defaults.
    Concerns have been heightened by the wild swings in market
interest rates since the collapse of Silicon Valley Bank
 SIVB.O  last week.
    Fund managers advise shunning high-yield bonds, despite
their attractive yields, because of the risk these bonds could
be hit by ratings downgrades, defaults and a squeeze in company
earnings.
    "Market concerns are elevated, given the uncertainty of a
recession this year, the path of inflation, and most recently,
the collapse of Silicon Valley Bank," said Jim Smigiel, chief
investment officer (CIO) at investment firm SEI.
    "Given the volatility of the past few days and the still
unfolding situation within financials, the turmoil in the
banking sector could certainly increase outflows and further
test the system."
    The demand for high-yield bonds has faltered since February
due to a rise in U.S. Treasury yields, as strong economic
activity bolstered expectations that inflation would remain
sticky and the Federal Reserve would have to raise interest
rates more to contain it. 
    Refinitiv Lipper data showed high-yield bond funds, after
seeing an inflow of $7.63 billion in January, faced an outflow
of $11.51 billion in February.
    So far this month, high-yield bond exchange-traded funds
(ETFs) have seen a total outflow of $506 million.
    However, safer money market funds have attracted $28.76
billion, and government bond funds have seen an inflow of $15.52
billion since February. 
    The ICE BofA Global high-yield bond index  .MERHW00  has
fallen over 3% since the start of February, making the yields
attractive at 8.7%.
    The yield spread between the BofA high-yield bond index and
the U.S. 10-year Treasury bond has risen to more than 500 basis
points for the first time since October. 
    Still, the spread is tighter than the 2,090 basis points
during the 2008 financial crisis and about 1,000 basis points in
2020 when the coronavirus crisis hit.
    "Investors should look to reduce exposure to the U.S. high
yield market at this time because we expect there will be a
better entry level in the near future," said David Norris, head
of U.S. Credit at TwentyFour Asset Management.
    "Once we can be sure that the Fed has reached or is close to
reaching the terminal rate, with the potential for a soft to
softish landing, investors at that point could begin to increase
exposure to high yield."  
    "In the meantime, investors should stay invested but move up
the credit spectrum to higher-rated bonds in more defensive
sectors, keeping a lower duration profile." 

    DEFAULT RISKS RISE 
    According to Fitch Ratings, the trailing 12-month U.S.
high-yield default rate stood at 1.6% in February, the highest
since June 2020.  The credit rating agency also says default
rates are poised to rise toward the historical average of 3.6%.
    Deutsche Bank predicts higher risks of defaults this year in
European high-yield corporate debt as they are increasingly
vulnerable to the slowing global economy.      
    "There's a huge wall of debt that is going to be maturing in
2024 to 2026 that is going to be resetting at much higher
interest rates than where it is fixed today," said Christopher
Zook, CIO of CAZ Investments. 
    "And so there's a lot of concern that there's going to be a
very significant increase in borrowing costs for these companies
that are going to have to refinance in 2024-2026."

    <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Fund flows: Global high yield bonds    https://tmsnrt.rs/3TgXeGO
Fund flows into global government bonds    https://tmsnrt.rs/3Fp53V7
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
 (Reporting By Patturaja  Murugaboopathy and Gaurav Dogra in
Bengaluru;Additional reporting by Davide Barbuscia in New York
Editing by Vidya Ranganathan and Mark Potter)
 ((patturaja.muruga@thomsonreuters.com;))