What Happened to High Yield?

December 17, 2015

The recent sell-off in the U.S. high yield market has caused concern among investors and many worry that the situation will worsen before improving; this is especially concerning because of its effects on portfolio values before calendar year-end. The Credit Suisse High Yield Index returned -1.08% on Friday, December 11th and recorded another down day when the markets reopened on Monday with a return of -1.39%. Through December 14th, high yield has dropped 4.15% for the month and 6.11% for the year. As of December 14th, the yield for the index is 9.42% and the spread is 774bp.

The declines reflect liquidity concerns in the high yield market after the closure of a junk-bond mutual fund. Many investors took advantage of low bond prices after the financial crisis, betting that the U.S. economy would recover. While that thesis proved to be a profitable one, there has been a gradual change in sentiment, with significant outflows in high yield mutual funds over the last three years, including $10.5 billion this year. So what is driving this liquidity concern and subsequent sell-off?

Many would argue that the prolonged period of low oil and other commodity prices are the primary drivers of the sell-off, and are expected to drive default rates higher for the energy portion of the high yield index. As shown in the chart above, energy and metals/minerals constitute roughly 18% of the index. With commodity prices struggling and OPEC not willing to slow production in oil, the fear is that the underlying prices will continue to fall. A further fall in prices — particularly in the energy and metals/minerals industries — will lead to greater revenue losses and a higher likelihood of defaults. Although default rates for the other sectors of the index are expected to remain close to their long-term averages, high yield funds with a significant overweight to the energy and metals/minerals sectors may suffer above average losses over the coming year.

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

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