02.11.21

Many investors struggle with today’s interest rate levels. Given that the 10-year U.S. Treasury yield is near historical lows, those seeking yield have fewer places to invest. Negative real yields - bond yields after accounting for inflation - for investment grade corporates are further driving investors into other areas of the market. We believe two areas of the high yield market offer strong risk-adjusted total return potential along with high dividends: bank loans and below BB-rated corporate securities.

AVERAGE YIELD

Source: Bloomberg. Data as of 12/31/20.

Bank loans

A bank loan, also known as a leveraged loan or senior secured credit, is a commercial loan provided by a group of lenders. Loans are sold (or syndicated) to other banks or institutional investors. They are typically offered with floating interest rates that adjust monthly and are quoted at LIBOR plus a spread. Based on the floating rate feature, loans performed poorly over the last few years as the Federal Reserve (Fed) cut interest rates to near zero. However, with a current base of zero, loans offer attractive dividends and potentially grow further as rates move away from the zero base.

Despite lower rates, the loan market has grown in significance and liquidity over the last ten years, increasing from $450 billion in 2010 to $1.2 trillion in December 2020. This compares to the high yield market’s $1.5 trillion.

Loans can provide a few key advantages over bonds:

• Downside mitigation — Loans have collateral, typically bonds do not. That makes a difference when it comes to recovery rates in the event of a bankruptcy. Historically, if a secured loan files bankruptcy there is a 70–80% recovery versus a 30–40% recovery for an unsecured bond.
• Floating rate — Nearly all major classes are subject to interest rate risk. Loans typically have a floating rate, which helps eliminate interest rate risk. That’s one of the reasons loans have the top Sharpe ratio across asset classes as there is less interest rate volatility. Given historically low rates today, it’s difficult to see them going lower. If rates move up, however, loans provide protection that most asset classes don’t offer.
• Yields — Bank loan investors are currently able to achieve higher yields with greater downside protection. Loans ended 2020 with a 5.1% yield to 3-year takeout versus a yield to worst of 4.71% for high yield bonds.
• Spread history — Loan spreads ended the year above their 5-year average, whereas high yield bonds were slightly below their 5-year average.

Credit

From the market bottom on March 23 through December 31, high yield bonds, as measured by the ICE BofAML U.S. High Yield Index, have outpaced the Bloomberg Barclays U.S. Aggregate Bond Index by over four times, returning 30.6% compared to 7.5%, respectively. Technicals have been strong as the high yield market has been open for nearly any company wanting to raise capital, outside the energy sector and a small portion of retail. In fact, the annual high yield new-issuance record was broken in the first nine months of 2020. BB-rated companies are accessing the market at levels investment grade credits once aimed to achieve. In November, a record high 49% of high-yield bonds yielded less than 4% ($699 billion) versus 42% when yields reached a record low in 2013. Fallen angels now make up a large portion of the high yield space at rates below 4%.

High-yield credit spreads tell a similar story as spreads have tightened nearly 600 bps since March 2020. Spreads widened out to more than 1,000 bps in mid-March, a level reached only twice in the past two decades — once after the 2008 global financial crisis and the other following the tech bubble.

Ratings we find attractive right now

Our belief is that ratings agencies are often lagging indicators and many companies are far stronger than current credit ratings indicate. In the current environment, we are finding the most attractive opportunities within the single-B rated and below portion of the high-yield market. Historically low rates allow these companies to work through difficulties, and recent volatility has resulted in many securities trading down in tandem. Identifying mispriced securities can boost a portfolio’s performance and diversification, which requires a selective approach combined with exhaustive credit analysis. The Ivy High Income Fund’s dedicated team of high yield analysts often spend weeks researching individual names to ensure creditworthiness along with strong management, businesses and balance sheets.

Risk and Reward

During the downturn from February to March 2020, investors allocated to BB-rated bonds, which outperformed those with lower credit ratings. However, we believe there is currently more value to be derived in B and CCC-rated bonds as fundamentals improve and the access to capital continues to be widely available.

Source: JP Morgan. Data as of 12/2/2020.

TRAILING 12–MONTH SPECULATIVE GRADE

Source: J.P. Morgan, “JPM High-Yield and Leveraged Loan Morning Intelligence.” 12/3/20.

High-yield default rates appear to have peaked

Defaults are important to evaluate when investing in high yield. Many observers expect the overall level of defaults may have peaked. We believe the pandemic likely pulled forward many corporate defaults that may have happened regardless. Energy companies have been under pressure for years and the low price of oil makes it more challenging for highly leveraged oil producers to stay afloat. The “death of retail” also has been a story line for many years due to the proliferation of e-commerce. Yet to be seen is the impact of the second wave of COVID-19 cases, but the news of effective vaccine may buffer some of the economic impact.

Going forward

In terms of the view going forward, we think once the Pfizer and Moderna vaccines get through the system, the subsequent six months will generate robust gross domestic product (GDP) growth. Then the question becomes, does the market change the Fed’s rate trajectory? Overall, we see the outlook for 2021 as constructive. If things play out in the back half of 2021 in which GDP growth continues to be robust, investors could get a coupon-plus-return type of year in high yield. Alternatively, if there are questions regarding inflation and the Fed is seen as being behind the curve, we could see increased volatility.

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Past performance is no guarantee of future results. future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through February 2021, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and

Risk factors: Risk factors: The value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Fund may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Loans (including loan assignments, loan participations and other loan instruments) carry other risks, including the risk of insolvency of the lending bank or other intermediary. Loans may be unsecured or not fully collateralized may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be oered

The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes treasuries, governmentrelated and corporate securities, MBS, ABS, and CMBS.

The ICE BofAML U.S. High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. It is not possible to invest directly in an index.