The Lure of Long-Term Value
What We Are Seeing
In 2023, we expect to see a shift in focus toward slowing global growth. Monetary policy will remain a prominent market driver, but the prospect of recession in several developed markets will likely be a trigger for volatility throughout the year.
In high yield, corporate fundamentals still appear to be somewhat resilient, and the market is entering 2023 from a place of relative strength. Leverage appears to be manageable, and interest coverage is hovering near all-time highs.
However, strong fundamentals at the end of 2022 are likely to weaken in 2023. In particular, we expect corporate earnings to fall in line with slowing business activity at the same time that interest coverage softens — especially for issuers with elevated exposure to floating-rate debt.
Primary issuance, which remained languid throughout 2022, may start to increase in 2023 as companies become more comfortable with a regime where interest rates remain higher for longer.
What We Are Watching
Receiving adequate compensation for taking credit risk is what drives our investment decisions. Therefore, we are re-underwriting our investments to ensure appropriate payment for the underlying risks, while also seeking out attractive upside in an environment of rising credit risk.
We deem current valuations to be fair, on average, but foresee further spread widening as the most likely path forward. Should spreads move materially wider, we could see an entry point emerge that offers the potential for attractive long-term risk-adjusted returns. To this end, taking a disciplined approach to incrementally adding risk when credit spreads surpass defined thresholds will be key for high yield in 2023.
What We Are Doing
We have reduced exposure to cyclicals and segments exhibiting unattractive asymmetric risk/return characteristics. We prefer defensive sectors trading wide of historical norms. For example, the health care sector's average spread typically trades at around 40 basis points (bps) tighter than the ICE BofA U.S. High Yield Index average, but the sector traded 158 bps wider on November 30, 2022.
We are maintaining a bias toward higher-quality credits and issuers with durable free cash flow — particularly within high-margin, service-based segments that benefit from strong recurring revenue.
Finally, we stand ready to add risk in a disciplined manner when spreads exceed defined thresholds.
Stephen C. Concannon, CFA
Co-Head of High Yield
Portfolio Manager
Will Reardon
Institutional Portfolio Manager
High Yield
The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment. Past performance is no guarantee of future results.
ICE BofA U.S. High Yield Index is an unmanaged index of below-investment grade U.S. corporate bonds.
