Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 213

Watch the low returns on 'high yield' debt

It is boom time once again for global ‘high yield’ debt. It’s great for borrowers wanting cheap debt with few conditions but bad for long-term investors. Both investment grade and high yield debt carry more leverage than 10 years ago but interest servicing costs are lower. In effect, lower interest rates have allowed corporates to borrow more without having to pay more in interest.

The first graph from Bloomberg on US high yield shows the breakdown of US high yield bonds into rating categories. Compared to a decade ago, the higher quality BB’s make up a greater portion of the index, with B’s much less than 20 years ago, and CCC’s shrinking since the days of the GFC. That’s a good thing, though it needs to be considered alongside two other factors that aren’t so positive.

The bad news for high yield investors is that covenant quality is worse than it has ever been. The graph below tracks the proportion of US and European sub-investment grade loans that have minimal or no covenant protection. Asia isn’t faring any better, covenant-light bonds are at 61% of issuance in Singapore and 72% in Hong Kong. Fewer covenants mean that sick companies are allowed to operate unchecked for longer. A lack of covenants increases the proportion of debt that suffers monetary defaults and reduces the recovery rate.

The last key characteristic to note is that spreads over base rates are near the lowest in the last 10 years. US High Yield bond spreads are shown below, but the story for European debt and leveraged loans is the same. There’s been a wave of loans being repriced in the US and Europe this year; situations where borrowers reduce the spread they pay, usually without providing any offsetting risk reduction. Borrowers clearly have the whip hand over lenders.

Spreads are now at the level where the B and CCC rated segments are barely positive if historical average losses are subtracted. Not surprisingly, many are saying that now is the time to be a contrarian and sell high yield. Edward Altman sees high yield conditions as bad as 2007 and Howard Marks similarly warned about conditions in his latest memo. The initial yields on offer may look comparatively high, but that’s no guarantee of high returns in coming years.

 

Jonathan Rochford is Portfolio Manager at Narrow Road Capital. This article has been prepared for educational purposes and is not a substitute for tailored financial advice. Narrow Road Capital advises on and invests in a wide range of securities.

 


 

Leave a Comment:

banner

Most viewed in recent weeks

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 606 with weekend update

The boss of Australia’s fourth largest super fund by assets, UniSuper’s John Pearce, says Trump has declared an economic war and he’ll be reducing his US stock exposure over time. Should you follow suit?

  • 10 April 2025

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

Latest Updates

Investment strategies

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Investment strategies

Does dividend investing make sense?

Dividend investing offers steady income and behavioral benefits, but its effectiveness depends on goals, market conditions, and fundamentals - especially in retirement, where it may limit full use of savings.

Economics

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

Strategy

Ageing in spurts

Fascinating initial studies suggest that while we age continuously in years, our bodies age, not at a uniform rate, but in spurts at around ages 44 and 60.

Interviews

Platinum's new international funds boss shifts gears

Portfolio Manager Ted Alexander outlines the changes that he's made to Platinum's International Fund portfolio since taking charge in March, while staying true to its contrarian, value-focused roots.

Investment strategies

Four ways to capitalise on a forgotten investing megatrend

The Trump administration has not killed the multi-decade investment opportunity in decarbonisation. These four industries in particular face a step-change in demand and could reward long-term investors.

Strategy

How the election polls got it so wrong

The recent federal election outcome has puzzled many, with Labor's significant win despite a modest primary vote share. Preference flows played a crucial role, highlighting the complexity of forecasting electoral results.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.