Q&A: Are high-yield bonds still a place to be?

12-31-2013

High-yield bonds had another strong year in 2013, the fifth straight year of relatively strong performance. Is there reason for continued optimism for this asset class in 2014? We asked Senior Portfolio Manager Mark Durbiano for his views.

Q: What is your outlook for high yield in the coming months? We continue to like the prospects for high-yield bonds as we enter 2014. In fact from our perspective, it may be one of the most attractive fixed-income asset classes for investors to target. That said, investors need to have realistic expectations given that we may be in a rising-rate environment. Our view is that, as was the case over the past year, 2014 will be a coupon clipper’s market. In a potentially rising-rate environment, interest gains from high yield should continue to deliver an attractive return, relative to many other fixed-income alternatives.

Q: What factors are likely to support the high-yield asset class? There are three primary factors. First, the domestic economy is solid. If anything, it may surprise to the upside. Second, and equally important, corporate credit quality continues to be stable. Most corporate issuers have solid earnings, good cash flows and moderate debt levels. Also, by and large, corporations remain focused on improving their overall credit quality, a key factor for high-yield bonds. Finally, we believe valuations continue to be fairly attractive in the high-yield market. Though not quite as attractive as they were two or three years ago, given the positive economic outlook and solid issuer fundamentals, we believe valuations are reasonable and should support high yield in 2014.

Q: Do you foresee impacts from the Federal Reserve taper? As the Fed continues to roll back its bond purchases, we expect a fairly muted impact in the high-yield market. Early on, the Fed indicated that one of its conditions for tapering would be a strengthening economy. Strong economies are typically a positive for high-yield issuers. As credit spreads narrow, this should help offset some of the interest rate rise that may occur as tapering begins.

Q: As the year progresses, what are you watching? There are two main factors that could lead us to become a bit more defensive on the high-yield market. One is valuations. As I noted, given the overall improving economic picture, we believe valuations are relatively attractive at this time. We’re also keeping a close eye on corporate credit quality. A typical indicator of an over-extended market—and higher default rates—is when new issuers enter the market with very high debt levels and minimal free cash flow to service that debt. These two factors are what led us to become more defensive in 2006, perhaps a bit early, but as 2007 and 2008 unfolded, it turned out to be very good positioning.

Thank you, Mark.

Mark E. Durbiano
Mark E. Durbiano, CFA
Senior Portfolio Manager, Head of Domestic High Yield Group, Head of Bond Sector Pod/Committee

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risk and may be more volatile than investment-grade securities. For example, their prices are more volatile, economic downturns and financial setbacks may affect their prices more negatively, and their trading market may be more limited.
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