May 30, 2023
The US high-yield market has contracted by 11% since its peak in December 2021, providing a potentially powerful tailwind for the asset class. For context, prior to this, the largest contraction of this universe occurred between 2016 and 2019, when it shrank by 8%.
Source: BofA, Bloomberg, April 2023. Index = BofA US High Yield (HUC0).
Global credit markets have seen significant growth in the post-GFC era, from investment-grade through to high-yield and leveraged loans. But within sub-investment grade markets, paltry new issuance volumes in much of 2022 and the early part of 2023 have caused some of these markets to shrink substantially (in terms of their face value), as we noted in our latest Credit Chronicle. In these markets, the volume of debt maturities, calls, tenders, coupon reinvestment, fund flows, and rising-stars departing the index (high-yield debt upgraded to investment grade) has significantly outweighed new issue volumes and entries to the index by fallen angels (downgraded investment-grade debt). This dynamic is no more apparent than in the US high-yield market, as shown in the chart.
Significant contractions in market size such as this often act as very supportive technical tailwinds to credit spreads/prices, as investors have a smaller pool of assets to invest in. In our opinion, this is one of the key factors that has supported high-yield credit spreads year to date, reflected in this part of the credit market behaving remarkably well in the face of a variety of negative headlines surrounding a potential looming recession.
Crucially for investors, this phenomenon of asset-class shrinkage can be a powerful and supportive force for extended periods of time. However, caution is required and investors seeking to take advantage of this trend should be nimble - the tide will eventually turn and these technical dynamics can unravel very quickly.
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.