Beyond Fundamentals: High Yield’s Time to Shine?

Why we see a “Goldilocks” opportunity in the asset class

These are interesting days. Investors are rightly concerned about a few things. There are two main issues: 1) inflation and interest rates, and 2) the overall economy and the potential for a slowdown. Here’s how we see the landscape.

The Current Default Environment

So far in 2023, the default rate is quite low, running below historical averages. We think there will be a pickup in defaults as the economy slows down, but we do not predict default rates will go to the levels we have observed in the past, such as during the Great Financial Crisis, for example.1 We think companies’ balance sheets are in better shape now than they were back then.

Figure 1: Default Rates, 1998-2022

Source: JP Morgan, as of February 28, 2023.

Companies could default in two ways—either by running out of money or hitting a maturity wall. Because rates have been so low for so long, many companies have taken advantage of that to refinance and extend their debt maturities. They have also used strong capital markets to build significant liquidity.

So, while we think there will be a pickup in the default environment, we do not believe defaults will reach the levels we’ve seen in the past.

Why We Believe High Yield is Compelling Now

We think high yield is an attractive asset class because investors are getting paid almost 9% yield, over three times the spread of investment grade debt. This is happening with lower interest rate risk because of the shorter duration of high yield. It also doesn’t require investors to take excessive default or restructuring risk because we think companies coming into this economic slowdown are in better shape than they were in the past.

This is why we feel that high yield is a “Goldilocks” asset class right now in terms of its exposure to interest rate risk and credit risk. And when you look at the current yield versus history, it’s one of the largest amounts offered to debt investors over the past 20 years.

Figure 2: Rolling Month-End Yields for ICE BofA US High Yield Index (Yield-to-Worst), 2002-2022

Source: Bloomberg, as of February 28, 2023.

What Protects High Yield Investors?

For us, the answer has always been, “Doing your homework.” We do extensive homework upfront to understand companies, their underlying businesses, and economic crosscurrents. Our selective approach means we seek a few dozen securities that we believe have safe principal protection while paying a little more than the rest of the market. That’s the “bread and butter” of our approach to alpha generation.

Important Disclosures
1The Great Financial Crisis refers to a period of extreme stress in global financial markets and banking systems between mid-2007 and early 2009. During this period, the S&P peaked in Oct-2007 and bottomed in Mar-2009.

This information is provided for illustrative purposes only. Opinions and views expressed constitute the judgment of Polen Capital as of April 2023 and may involve a number of assumptions and estimates which are not guaranteed and are subject to change without notice or update. Although the information and any opinions or views given have been obtained from or based on sources believed to be reliable, no warranty or representation is made as to their correctness, completeness, or accuracy. Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice, including any forward-looking estimates or statements which are based on certain expectations and assumptions. The views and strategies described may not be suitable for all clients. This document does not identify all the risks (direct or indirect) or other considerations which might be material to you when entering any financial transaction. Past performance does not guarantee future results and profitable results cannot be guaranteed.

The ICE BofA 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 maintained by ICE Data Indices, LLC.

The volatility and other material characteristics of the indices referenced may be materially different from the performance achieved by an individual investor. In addition, an investor’s holdings may be materially different from those within the index. Indices are unmanaged and one cannot invest directly in an index.