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Key takeaways:
- Amid an era of ultra-low rates, high-yield (HY) bonds1,2 could emerge as an optimal income source for a multi-asset portfolio, compared with traditional government bonds.
- With a recovering economy, default rates have begun to decline from 2020 highs. In a market environment currently supportive of risk assets, active management is key in the pursuit of potential HY income opportunities.
The pursuit of income is a continuous journey. Over the past decade, income investors like us have stayed the course as we ride through the four seasons, employing an active investing approach as we navigate the markets’ ups and downs. With interest rates looking to stay at ultra-low levels for longer, active management, which integrates macro asset allocation views and the bottom-up, yield-focused insights of asset class specialists, is crucial in tapping income opportunities through the seasons.
Exploring high-yield potential as winter passes by1
After a tumultuous 2020, investors are keeping a close tab on the process of economic reopening around the world. Returns from traditional bond sectors have become relatively unattractive as unprecedented monetary and fiscal policies are keeping rates lower for longer, alongside the possibility of rising inflation further down the road.
Fixed income assets with high-yielding potential like HY bonds have thus become a relatively attractive income source to a multi-asset portfolio. Yield of US HY credit stood at 4.2%3, as of end-December 2020, a comparative compelling level compared with traditional income sectors such as government bonds.
Cash and most government bonds are delivering negative real yields3
‘Green shoots’ potential in the spring as opportunities emerge in high yield
From an asset allocation perspective, we believe potential opportunities in HY bonds are emerging with defaults on the decline and relatively attractive yield potential.
1. Defaults began to decline
- US HY bond defaults4 spiked in 2020, increasing from 2.66% in January to 6.22% in July. Defaults began to see a mild decreasing trend as of December and continuous improvement is expected as economy gradually recovers
With the US Federal Reserve committed to its asset purchases programme and holding rates at near zero, companies could continue to raise public financing to repay their debt and deleverage their balance sheets. Gross new issuance of US HY bonds reached US$450 billion for 2020 through end-December5.
Additionally, European HY bonds also offer potential diversification benefits as they are generally of higher quality and have shorter duration.
2. Attractive yield potential
- HY credit spreads6 are now narrowed to about 440 basis points from over 900 basis points in March 20204, providing ample cushion to absorb any additional defaults. Still, HY spreads have remained above pre-public health crisis levels.
Active management through all seasons
- Through the decade, portfolio managers of JPMorgan Multi Income Fund have been actively adjusting the Fund’s HY bond allocation to manage portfolio risk, while seeking income consistently in changing market conditions.
| How does JPMorgan Multi Income Fund actively manage its HY allocation7? |
2018 (added a quality tilt to navigate the late cycle)
| INITIATED EXPOSURE TO EUROPEAN HY |
The European high-yield market has a higher credit quality profile and shorter duration than its US counterpart, and provides a source of diversification for our still significant allocation to US high yield.
The recent political and trade-related volatility in European high-yield markets has pushed European credit spreads wider than those in the US market. This dynamic presents an attractive relative value opportunity, as the European high-yield market traditionally trades with narrower spreads than the US market, given its higher credit quality profile.
2021 (recovering from the global public health crisis)
| AVOIDING SECTORS WITH HIGH DEFAULT RISK |
Some sectors such as energy and basic materials are facing considerable financial pressures, and we continue to take an active investing approach and a focus on quality to minimise allocation into sectors that are facing potentially higher default risk.
Moving into 2021, the economy is still recovering from the public health crisis. Taking an active investing approach and a focus on high-quality issuers as well as keeping an eye on liquidity conditions are crucial to optimise the relatively attractive valuations and to better manage any default risk.
Default risks diverge between sectors8
Conclusion
With a recovering economy and defaults on the decline, interest in HY bonds is gaining traction, especially as rates continue to stay low for longer. Investors, depending on their investment objectives and risk appetite, could keep an eye on the emerging opportunities in HY bonds for higher income potential.
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Provided for information only based on market conditions as of date of publication, not to be construed as investment recommendation or advice.
High-yield credit refers to corporate bonds which are given ratings below investment grade and are deemed to have a higher risk of default. Yield is not guaranteed. Positive yield does not imply positive return. Diversification does not guarantee investment return and does not eliminate the risk of loss.
1. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.
2. High-yield credit refers to corporate bonds which are given ratings below investment grade and are deemed to have a higher risk of default. Yield is not guaranteed. Positive yield does not imply positive return.
3. Source: Bloomberg Barclays, J.P. Morgan Asset Management. Data as of 31.12.2020. Representative indices: iShares US Preferred Stock ETF Index (Preferred equities), Bloomberg Barclays Credit Rate Sensitive Index (Convertible bonds), Bloomberg Barclays US Corporate High Yield 2% Constrained Index (US high yield), BofA Merrill Lynch Euro Developed Markets Non-Financial High Yield Constrained Index (European high yield), J.P. Morgan EMBI Global Diversified Index (Emerging markets debt), Bloomberg Barclays US IG Credit Index (US investment grade credit), US 10-Year Treasury Index (US 10-year treasury), German 10-Year Treasury Index (German 10-year treasury), Japan 10-Year Treasury Index (Japan 10-year treasury), USD Cash Index (USD cash). Indices do not include fees or operating expenses and are not available for actual investment. Yield is not guaranteed. Positive yield does not imply positive return. Investments involve risks and are not similar or comparable to deposits. Provided to illustrate general market trends not to be construed as research or investment advice.
4. Source: J.P. Morgan Economics Research, J.P. Morgan Asset Management. *Default rate is defined as the percentage of the total market trading at or below 50% of par value and includes any Chapter 11 filing, pre-packaged filing or missed interest payments. Spreads indicated are benchmark yield-to-worst less comparable maturity Treasury yields. US corporate high yield is represented by the J.P. Morgan Domestic High Yield Index. Data reflect most recently available as of 31.12.2020.
5. Source: J.P. Morgan, Bloomberg Finance L.P., Lipper FMI. Data as of 31.12.2020.
6. Spreads refer to the interest rate differential between two different types of bonds.
7. Source: J.P. Morgan Asset Management. Data as of 31.12.2020. The Fund is an actively managed portfolio; holdings, sector weights, allocations and leverage, as applicable are subject to change at the discretion of the Investment Manager without notice. These represent Multi-Asset Solutions team’s views under current market conditions, subject to change from time to time. Provided for information only, not to be construed as investment advice.
8. Source: Bloomberg Barclays, J.P. Morgan Asset Management. Data as of 31.12.2020. *Option-adjusted spread of bonds trading above 1,000bps. Comparator = Bloomberg Barclays US High Yield Index – 2% Issuer Cap. **Portfolio weight of the standalone US High Yield allocation of the JPMorgan Multi Income Fund. The Fund is an actively managed portfolio; holdings, sector weights, allocations and leverage, as applicable are subject to change at the discretion of the Investment Manager without notice.
Investment involves risk. Not all investments are suitable for all investors. Past performance is not a reliable indicator of current or future results. Please refer to the offering document(s) for details, including the risk factors. Investors should consult professional advice before investing. Investments are not similar to or comparable with fixed deposits. The opinions and views expressed here are as of the date of this publication, which are subject to change and are not to be taken as or construed as investment advice. Estimates, assumptions and projections are provided for information only and may or may not come to pass. This document has not been reviewed by the SFC. Issued by JPMorgan Funds (Asia) Limited.
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