To have or have not in US high yield

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      By Kelley G. BacceiHigh Yield Portfolio Manager, Eaton Vance Management and Will ReardonInstitutional Portfolio Manager, High Yield

      Boston - We've noticed that the US high yield market has become increasingly bifurcated over the past year — essentially dividing the universe into the "haves" and the "have nots." We believe that bifurcation mainly stems from investors' reluctance to add risk to less liquid exposures this late in the cycle.

      The dispersion becomes apparent when we look at how the yield to worst (YTW)1 distribution among high yield issuers has changed over the course of 2019. At the end of 2019, approximately 22% of the ICE BofAML US High Yield Index2 traded at a yield within 100 basis points (bps) of the index average YTW of 5.41%,3 with almost 58% yielding 100 bps less and 20% yielding 100 bps more than the index. That's down from almost 30% yielding within a 100 bps band around the index YTW at the end of December 2018.


      When we compare the distribution of YTW in the US high yield market after the higher-quality rally in 2019, what is most pronounced is that the number of issues yielding less than 4% has increased from less than 10 to more than 700. Meanwhile, the number of issues yielding more than 20% has also grown, despite a beta-led rally last month fueled by outperformance in the energy sector.

      Cohort of "have not" credits

      Although easing by central banks has definitely helped to reduce yields overall, there's still a large cohort of high yield credits that have not experienced a notable contraction in yield — primarily issues rated CCC and below. This reflects troublesome fundamentals unique to these "have nots," and over the course of 2019, CCC-rated issues underperformed BB and B-rated issues, as well as the broader market.

      To an extent, investors appear reluctant to add risk in less liquid exposures. However, the "have nots" are issuers that have cracks in their company fundamentals, often called zombie credits. Some issuers are plagued with bimodal outcomes depending on regulation or the price of a commodity. Others have untenable capital structures, which can limp along following distressed debt exchanges but will have to restructure at some point.

      We expect this trend in dispersion to continue and remain leery of indiscriminately reaching for yield, despite what appear to be relatively full valuations in much of our market. Although we continue to look for attractive idiosyncratic risk within the lower tier, we believe that it would be prudent to continue to avoid the "have nots."

      Bottom line: In 2019, a dovish US Federal Reserve certainly put downward pressure on yields and helped lift bond prices, leaving very little upside in the higher-quality portion of the market. Nevertheless, we believe that investors may not be rewarded for dipping into the growing bucket of distressed credits in the high yield universe. Making sound credit decisions is paramount in this type of late-cycle environment, and investors can no longer blindly grab for yield.