Data as of March 31, 2021, unless otherwise noted.
Performance (total returns)
|Bloomberg Barclays U.S. Aggregate Bond Index (Barclays Agg)||-1.25%||-3.37%|
|ICE BofAML U.S. High Yield Master II Index (HY Bonds)||0.17%||0.90%|
|S&P/LSTA Leveraged Loan Index (Senior Secured Loans)||0.00%||1.78%|
Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.
Leveraged credit’s climb stalled slightly in March: HY Bonds eked out a slight gain as a surge on the last trading day of the month put the asset class back in positive territory after declining for much of March. Senior Secured Loans ended the month flat, ending an 11-month streak of gains. The interest rate volatility that began in late February continued for much of March, causing periods of risk-off sentiment which weighed on credit markets. The search for yield appears paramount this year as the riskiest assets have continued to outperform. CCCs are now outperforming BBs in both markets by over 500 bps YTD, and second-lien loans have outperformed first-liens. HY Bonds saw record issuance in March and loan issuance volume for the first quarter also eclipsed previous levels. We believe that given this heightened issuance, many companies are well capitalized, having shored up liquidity and extended debt maturities. The overall technical picture in the HY market remains one of excess supply as retail outflows have continued, but rising stars have helped balance the picture somewhat. The loan market has seen strong demand from both retail and institutional investors, as the CLO primary market is off to its busiest start since the Global Financial Crisis (GFC). The fundamental backdrop for credit remains favorable. The passage of the $1.9 trillion stimulus package boosted GDP forecasts significantly, default rates were sent sharply lower last month, and ratings upgrades continue to outpace downgrades. The volatility in long-term interest rates sent the duration-sensitive Barclays Agg sharply lower, down -1.25% in March and -3.37% YTD.
One year after the market low, credit still has room to run: Spreads for HY Bonds and Senior Secured Loans have surpassed their pre-pandemic tights and are rapidly approaching post-GFC lows, prompting questions about just how low spreads can go. By ratings mix, the HY market has improved in quality in recent years while the quality of the loan market has deteriorated. All else equal, a higher-quality market should demand less spread compensation. In our view, given the strong economic backdrop and relative weighting of higher-quality assets, it is not unreasonable to think that HY Bond spreads could approach their all-time tight levels. BB rated bonds now make up over half (55%) of the high yield market while CCC rated bonds comprise just 12%. This compares to the loan market, where B rated issues make up the lion’s share at 57% while BB rated loans make up roughly 25%. This increase in B rated loans is largely driven by increasing loan-only issuance—loans to companies without subordinated bonds in their capital structures to act as a buffer for loan holders in the event of credit problems. Recovery rates for loan-only issuers that have defaulted over the past year is just 43%, compared with 59% for companies with both bonds and loans. We do believe that there can be idiosyncratic opportunities in the loan market, but experienced, active managers are best positioned to discern given this worrisome issuance trend.
- Interest rate volatility continued to weigh on markets for much of the month.
- HY Bonds eked out a positive return while Senior Secured Loans ended March flat.
- The duration-sensitive Barclays Agg continued to struggle, ending down -1.25%.