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