Five reasons to snap up high yield bonds

According to Legg Mason affiliate Western Asset, the sector experienced its worst third quarter for three years, as investors fled to US Treasuries and other government bonds.

In practical terms, the sell-off means US high yield spreads over Treasuries have jumped from around 340bps in June to as much as 500bps in September.

Michael Buchanan, Head of Global Credit at Western Asset, believes that such a large move up in such a short space of time has left high yield as one of the most attractive areas within fixed income that investors can access.

Below he highlights five key reasons why he believes investors should be considering the asset class today:

1. Yields of more than 6% are very attractive

“With the overall interest rate environment at very low levels, yields of 6% or more on some high-yield bonds have been capturing investors’ attention. To us, the spreads are now very attractive, and when combined with income from coupons and higher yields, high-yield bonds can offer strong income advantages over other fixed-income asset classes.”

2. Accommodative environment remains

“While the US Federal Reserve is expected to raise rates at some point, any rise is almost certainly going to be marginal, meaning the monetary backdrop remains highly accommodative. We’ve benefited from a very supportive Fed which wants to be thoughtful and careful, and we think the central bank will continue to be in play even as it steps away from this extremely accommodative environment. That is good for investors, as when rates are not a huge threat, it makes the water safer for fixed-income in general and credit in particular.”

3. Defaults remain muted

“High yield defaults remain near historic lows, continuing a trend started in 2010. While there has been a slight pick-up in defaults compared with 2013, we think they are likely to stay at or near these abnormally low levels given central banks’ stances.”

4. Recent sell-off has removed any “bubble territory” fears

“I know the attributes of a high-yield bubble and the current market does not have them. Investors have to look at yields compared to other fixed-income products, and following the recent sell-off those spreads are positive.”

5. Fundamentals look sound

“While US high yield fundamentals have worsened slightly over the past few years, they ultimately still look fairly sound. Whether you are talking interest rate coverage, leverage, free cash flow generation, or default rates: all of these are very supportive and have not really changed.”