Last year marked record issuance of high yield debt as companies with weaker balance sheets pounced on investor appetite for yield by selling large amounts of debt. In fact, Fitch Ratings data from the end of last year revealed European high yield issuance in 2012 smashed previous records by hitting €60.3bn – a 47% increase on 2011.
Industry players are expecting high yield to have another successful year. CAMRADATA research published last month revealed high yield bonds were in the predicted top three asset classes chosen by asset managers, pension fund investment professionals and insurance investment specialists.
And this week Aviva Investors said it foresees mid to high single digit returns for high yield, but warned investors will need to rein in their expectations compared to last year with a key driver being individual security selection.
Head of high yield investments Todd Youngberg added: “We expect companies to increase leverage, taking advantage of the low cost of debt relative to equity. Uncertainty has declined enough that even conservative companies will feel comfortable increasing their debt levels. Having dealt with upcoming liabilities, we believe company default rates are set to remain low for some time.”
The high yield success story has indeed been buoyed by this benign default rate environment which benefitted riskadjusted pricing in European high yield after the summer volatility. Defaults fell to 1.2% at the end of the third quarter of 2012, well below the historic average of 4.7%, according to the Fitch trailing 12-month HY Default Index.
However, consultant Redington’s latest RedVision newsletter out this week conversely noted that global corporate default rates actually rise in line with increased sales of high yield debt. It flagged up S&P estimates which show that among US companies alone the default rate for those with debt rated below investment grade will increase to 3.4 % by year-end, from 2.6% last December.
Redington observed throughout 2012 and the start of this year, investors have funded companies at higher risk of default and pushed their average yields to a record low of 5.61% last month, as they search for returns in a low interest rate environment. Yields since rebounded to stand at 6.02 % on Monday, according to Barclays data.
The low predicted default rate, as highlighted by Aviva, is of course good news but it seems to me that funding lower rated companies to take on more leverage and increase their debt levels, while creating opportunities, might actually have investors thinking twice before investing in the asset class and add another twist to the ‘Great Rotation’ debate.
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