Janus Henderson Investors: Avoiding a retest

Janus Henderson Investors: Avoiding a retest
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In this video Tom Ross, corporate credit portfolio manager at Janus Henderson Investors explains why he believes the credit spread wides of March for high yield bonds are unlikely to be retested.

19.10.2020 | 12:20 Uhr

Key Takeaways

  • Extensive fiscal programmes such as the furlough schemes to support employment, together with central bank support to help companies bridge the gap across the economic shock of COVID-19, have brought confidence back to the high yield bond market.
  • Companies typically offer a higher yield on new bond issues than existing bonds to attract investors, but these new issue premiums have receded or disappeared in recent weeks, increasing the relative attractiveness of the secondary market (bonds already issued).
  • The technical backdrop (supply and demand) for high yield bonds remains fairly strong, with appetite from a broad spread of investors for the asset class.



Video transcript


Hi, this is Tom Ross here, Portfolio Manager within the Global Corporate Credit Team here at Janus Henderson Investors. I want to give you a quick update on the high yield markets.

What has driven the recent rally in high yield bonds?

So, what has really driven the recent rally in the high yield market? Well, firstly I think the optimism around the recovery in economies around the globe has been much greater than the market was initially expecting and this was in line with our view that we have sort of been thinking about more recently. It seems like the virus is more under control. There are some risks there that we will come onto in a second but it is more the function that we are seeing global economies open up to a greater extent than we were initially thinking. And one of the reasons for this is, we believe, the extensive fiscal stimulus that has meant that whilst we have seen a rise in unemployment, the furlough schemes mean that the consumer is nowhere near as badly off as it would be during a normal crisis.

What are the key risks to the market?

So, what are the big risks from here? Well obviously there has been lots of talk about the risk of a second wave and we absolutely acknowledge that that risk is still there but what we would say is that the risk of a second wave of the virus won’t necessarily lead to the same level of lockdown and of economic shock as we saw the first time round. Firstly, most countries are better prepared this time. But it is also more the case – and we are starting to see evidence – that social distancing is actually working as well to control the virus as a full lockdown. So, we think it is unlikely that we will go back into one of those periods of full lockdown again and it also therefore means that the [credit spread] wides we saw in March are unlikely to be retested in the near future.

How effective has central bank policy been?

So, how effective has policy been for the high yield market? Well, it has been really significant. The central banks have provided such a significant amount of stimulus, almost two and a half times the US Federal Reserve has provided stimulus relative to what it did in the Global Financial Crisis. That’s really significant and they have really greased every single different part of the market to ensure that there is actually no liquidity issue. It has really helped the market to reopen. That’s the key aspect, here.

The market is able to self-heal with the Federal Reserve and other central banks as a backstop; it has allowed the new issue market to reopen. And that has really allowed companies to get the financing they need to bridge the gap across that big economic shock. So, it has been really significant. And I guess the other thing to add and another reason why the rally has been so strong recently is that Europe now really looks strongly together. And with the announcement of the European recovery fund as well as an increase in the PEPP, the Pandemic Emergency Purchase Programme, that has been really key in ensuring that Europe stays consolidated as one and really binds the North and the South of Europe much closer together.

Are new issues appearing attractive?

So, how attractive are the new issue premiums? Sadly, they are not quite as attractive as they were at the start of the new issue cycle. That’s typically how it works. But there are still selectively some opportunities. Now some of those new issue concessions have got very small and I guess that in some cases we have even seen deals priced tighter than the secondary market, which in fact just gives an indication that the secondary market is a little bit too wide and really highlights the grab for yield. But, generally, on the whole, selectively there are still really great opportunities to add risk through that new issue market and especially if you take an area like European high yield where actually there hasn’t been a huge amount of supply, then some of the opportunities there remain fairly good.

Is the technical backdrop supportive?

Overall the technical backdrop remains fairly strong. We have seen investors add risk but more up to neutral positions and covering (reducing) underweights as opposed to taking any significant overweight type of risk within the market. And end investors, and we have said this for a long time, we genuinely believe that end investors were quite underinvested in high yield and we are really seeing investors now look to invest in the market and those inflows are really causing extra demand for the market as well. So, the market dynamics remain fairly positive in that perspective.


Notes

Yield: The income that a bond pays as a percentage of its bond price. A bond paying €3 per annum with a price of €100 would have a yield of 3%.
High yield bonds: These are bonds issued by companies that are rated sub-investment grade by credit rating agencies as there is a higher risk that the company issuing the bonds may not be able to meet their obligations to bondholders. The bonds typically have a high yield to attract investors.
Credit spreads: the difference in yield of a corporate bond over a government bond of the same maturity.
Spread widening: this describes when the difference (spread) between the yield on a corporate bond and that of an equivalent government bond grows (widens), typically during periods of economic uncertainty and risk aversion when investors demand a relatively higher yield on corporate bonds. Spread tightening is where the difference narrows, typically due to optimism surrounding the economy and the outlook for a company.
Fiscal stimulus: government spending and/or lower taxation to help boost the economy
Furlough schemes: job retention schemes in which the government pays some or all of a worker’s salary while they are temporarily unable to work due to coronavirus restrictions.
US Federal Reserve stimulus: the US central bank had expanded its balance sheet by more than US$2.9 trillion in the first few months of the coronavirus (9 March 2020 to 1 June 2020) to help support the US economy, this compares with an expansion of US$1.3 trillion during the peak panic (15 September to 15 December 2008) of the Global Financial Crisis. Source: Refinitiv Datastream, US Federal Reserve total assets.
Pandemic Emergency Purchase Programme: An emergency monetary policy programme set up by the European Central Bank to counter some of the financial risks posed to the economic system by the coronavirus. It permits the ECB to purchase assets via the PEPP (up to €1,350 billion) to support the economy.
European recovery fund: a fund proposed by the Commission of the European Union (EU), potentially worth up to €750 billion that would be made up of grants and loans to help support the EU economy.
New issue premium: Newly issued bonds tends to be issued at a yield that is above the yield on similar bonds traded in the secondary market (already issued bonds) to encourage investors to buy the new issue.
Market technicals: the supply and demand environment for bonds, which contributes to the market price of bonds.
Overweight and underweight positions: an investor in the market with an overweight position in high yield bonds would increase their weighting above the typical benchmark weight for the asset class in their portfolio; the reverse is true for an underweight position. End investors means private or retail investors as opposed to institutional investors.

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