The chart
The overall index spread of the global high-yield market masks significant diversity and a skew towards the expensive part of the index.
Source: ICE BAML, Bloomberg, as at 22 June 2023. Index = ICE BAML Global High-Yield Index (HW0C).
The context
Last year we highlighted a notable lack of sector dispersion in credit markets, with limited pricing differentiation between defensive and cyclical sectors. As expected, the market has snapped back since then, with a combination of a flight to quality and mass retreat from riskier segments sending dispersion soaring. While we’re using the global high-yield market to illustrate this, the dynamic is playing out in a number of credit markets.
Dispersion within credit markets is not unusual, it is the current extent of this that is remarkable. Less than 21% of the global high-yield market is trading at similar (within 100bps) spreads to the index average; a whopping 55% is trading tighter, with a tail (around 10% of the index) of stressed constituents pulling the headline index spread wider to reasonably attractive levels.
The upshot is that ‘the market’ is, in effect, a portfolio comprising a skewed barbell of underlying bonds – at one end trading very tight to the market and at the other very wide. Furthermore, the skew to the tightest trading (most expensive) bonds makes this portfolio particularly vulnerable to a market correction.
The conclusion
While an environment of high market dispersion poses problems for investors that are looking to ‘buy the index’, it is typically the ideal hunting ground for credit pickers – investors with the freedom to select assets where the risk-adjusted returns are the most attractive.
As an example, currently the tightest parts of the BB rated segment of the US high yield market are trading tight relative to comparable BBB rated bonds in the US investment grade market, making the latter relatively more attractive from a risk-return perspective. This illustrates the benefit that can be derived from a flexible and targeted investment approach in such an environment.
More importantly, active credit pickers can also seek to avoid parts of the market that have become over-extended/expensive from a valuation perspective and particularly vulnerable to a correction. This is especially relevant against a backdrop of tightening liquidity and weakening global growth – conditions that will surely favour thoughtful portfolio construction in the coming months.
Past performance is not a reliable indicator of future results. The value of investments, and any income generated from them, can fall as well as rise.
