The global high yield market, which is defined as the worldwide market for below-investment grade corporate credit, regardless of domicile, has grown dramatically over the past decade. While the U.S. high yield market is still the largest, representing 68% of the $1.6 trillion global market, the European and emerging corporate debt high yield markets are expanding at faster rates.
Given the growth across the three markets, a global approach to high yield significantly increases the size of the investment universe. In addition, this approach may also enable investors to minimize risk by diversifying across industry and geographic sectors.
The results of such diversification have been impressive. Since 1999, the global high yield market has had only three periods of negative returns. While high yield is more volatile than other fixed income assets, it is also less volatile than equities. Over the last 10 years, global high yield has produced a significantly higher return with appreciably lower volatility than U.S. equities.
Given this scenario where diversification and lower volatility can be potentially rewarding for investors, a closer look at the three segments of the global high yield markets is necessary to better understand investment return and return volatility, and their default history. With this background, it’s much easier to understand how a combined approach can give investors access to upside returns even when certain parts of the market are struggling.
The U.S.The U.S. high yield market has shown consistent positive returns over the last 25 years—with only five years of negative returns—and an average annual return of 9.07%. Over the same period, equities have outperformed high yield returning 9.71% annually, but with substantially more volatility and higher risk. Overall, during this entire 25-year period—particularly during volatile economic and market cycles—high yield has outperformed equities on a risk-adjusted basis. For example, during the 2008 financial crisis, high yield returned a negative 26.39% versus a negative 37.00% for equities. In the recovery year that followed, high yield dramatically outperformed equities returning 57.51% versus 26.46%.
The development trajectory of the European high yield market is similar to the U.S. It began in the late 1990s, but the bubble burst in the early 2000s as the telecom/media sector became overbuilt.
The most recent stage of development—the refinancing phase—began growing in 2008 as corporations accessed the capital markets rather than going through banks for both new and refinancing needs as bank lending became tighter. The demand for high yield assets has now expanded to include European mutual funds, insurance and pension funds and global high yield investors.
While the European high yield market has exhibited higher returns than the U.S. and global high yield markets over the last 10 years (as hedged into U.S. dollars), it also has had significantly higher volatility. However, spreads will remain wider due to current economic concerns.
Emerging markets account for approximately 12% of the global market. They comprise countries except for the G-10, select Western European countries and Australia and New Zealand. Many high yield companies in these countries are active participants in infrastructure development and have growing middle class consumers—sectors that are expected to drive long-term growth.
Although emerging markets have matured, they still remain more volatile than other high yield markets due to accounting transparency issues, market size and participants and individual country bankruptcy laws. Over the last five years, investors have been compensated for this additional volatility as emerging markets have outperformed the global high yield market, returning 10.84% versus 10.66%, respectively.
The next move in fixed income assets will be a result of a rising interest rate. In this environment, high yield should outperform other fixed income investments because of its relatively shorter duration and higher spreads. Security selection, however, will continue to be key because of equity-like risks of high yield securities.
As global high yield markets continue to mature, the opportunity is broadening for investors seeking diversification. The global credit markets are integrating, but they also continue to have secular and cyclical characteristics. Clearly, a global approach to high yield increases the size of the investment universe and allows market inefficiencies to be potentially exploited.
Marianne Rossi, CFA, portfolio manager, High Yield Bonds, Stone Harbor Investment Partners
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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