Ivy High Income Fund - Investment Update
Commentary as of June 24, 2020
Derek: High-yield credit spreads widened much less during COVID-19 compared to the Global Financial Crisis. Spreads peaked on March 23, which is when the Federal Reserve (Fed) announced a number of programs to inject liquidity into the market. On April 9, the Fed announced it would purchase high-yield ETFs, which caused spreads to tighten following the announcement. Since the peak, high-yield credit spreads have tightened about 500 basis points (bps).
The Fed started buying credits in early May and hold $39 billion in corporate credit as of last week. We do not get a timely view of purchases, so we only have one holdings report thus far. Based on the data available from May 19 – at that point, the Fed only held $1.3 billion in corporate credit, 17% of which was in high-yield ETFs. The majority of Fed purchases are slated for investment-grade bonds with the rest going into high-yield ETFs. The Fed had been buying ETFs only; however, last week it announced it would start purchasing individual corporate bonds, which will include "fallen angels" in addition to ETFs.
There are several things to consider going forward. As a result of the CARES Act, the Fed received $454 billion from the U.S. Department of the Treasury, which was basically seed capital to execute programs for buying securities or making loans. The Fed uses that seed money as equity and then levers it up, dividing the money between the different programs with each program having a different leverage ratio. It allocated $37.5 billion in equity to purchase corporate credit, and with leverage has the capacity to purchase over $350 billion in corporate credit. It does not mean they will buy that much, but they will purchase enough to ensure fixed income markets function properly.
In terms of rate policy, the Fed’s median forecast is for rates to stay at zero through the end of 2022. We believe there is a high probability the zero rate policy extends beyond 2022. The Fed is also considering yield caps for U.S. Treasuries. That has implications for rates and the high-yield market.
Lastly, it's too early to say who will win the election, but Joe Biden has recently gained momentum. If he were to win the election, along with Democrats gaining control of the Senate, there would be an expected push for higher corporate taxes and also to tighten up on the regulatory environment around energy and the oil patch. Obviously, this has an impact on energy and the high-yield space. These are just a few areas that I am thinking about going forward.
Chad: The last update on the Fund and the high-yield space was three months ago – and the market has been "risk-on" since that time. During this time, the Ivy High Income Fund has had a strong return profile, while high-yield credit spreads have tightened about 500 bps. Additionally, there has been a record amount of issuance and markets have been open for all who have sought additional capital. Fund flows, especially on the ETF side, have subsided over the last two weeks, which something we are monitoring closely.
Over the last three months, we have kept up with the market snapback and are about even with the benchmark, but our leveraged loan portfolio continues to drag on performance. The average price of bonds was around 99 cents on the dollar before COVID-19 and now trade at about 94 cents on the dollar. Comparatively, loans are still down at around 84 cents on the dollar, so the loan portfolio has not come back all the way yet. Typically loans have an average maturity of about 3 years, so those with 2022-2023 maturities will be looking to push out to 2025-2026 via refinance. When that happens, the "pull to par," or the movement of the security’s price toward its face value as it approaches maturity, is expected in turn. That is why we continue to hold 24-25% in loans.
Of the big risks we’re monitoring, we are looking at increases in hospitalizations in Florida, Texas and elsewhere, as well as how the fall evolves in terms of the virus and the elections. It's difficult to predict elections as we saw last time around.
How is the Fund positioned in terms of credit quality?
Chad: The Fund’s CCC exposure is roughly around 30% based on S&P ratings, which is the max. A lot of the issuance has been in the BB space. Companies that issued in March with higher quality have been positive and we picked up some of those issues.
How does the money from the Fed influence your decisions?
Chad: The Fed stated it will keep rates low for an extended period of time. If stimulus works and the economy gets growth rates of 3%, then it allows the Fed to raise rates. There is essentially zero risk to state that low rates will be around for many years. The Fed has been adamant about not introducing negative rates. In our view, the Fed's position of holding rates low should benefit the Fund.
What environment do you believe leveraged loans would do well in considering the Fed may keep rates low for a while?
Chad: It's more of a “pull to par” play. If a security is at 84 cents on the dollar going to par when the company moves to refinance or push the loan out, then the potential is to earn 16 points plus par. That's why we are maintaining the exposure we have today. In terms of position, 19% of the Fund’s loans are first-lien. If there is an opportunity to get par in less than two years, then the total return is still attractive.
Past performance is no guarantee of 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 June 24, 2020, 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 time horizon.
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 offered at all broker/ dealers.
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.