Follow Comments Following Comments Unfollow Comments

After several rounds of volatility in recent weeks, prices in the high yield bond market are lower. The average yield today is about 6.1% compared with less than 5.2% at the end of June. But the shake-up has affected more than just prices. The MacKay Shields High Yield Corporate team say they’ve seen some new trends emerging lately. One example is the way that the market is pricing risk.

Markets Are Discriminating More Between High and Low Quality Issuers

As bonds have sold off, a bigger gap has emerged in spreads between higher and lower-quality issuers. This tells us something about the market’s attitude to credit risk. For example, the difference in spreads between the highest- and lowest-rated high-yield credits gives a measure of the risk premium that investors demand for moving down the credit-quality spectrum.

In February they were earning an extra yield of roughly 4.4%—very slim by historical standards. Today, that premium is back to around 6%. So, while investors were not previously making much distinction between companies with strong and weak fundamentals, indications are that they’re now paying more attention to things like asset quality and earnings again.

Markets Are Discriminating More Between Large And Small Issuers

While the gap in spreads between high and low quality issuers has widened, the team’s traders say they’ve also been seeing a bigger gap in spreads between large and small issuers. This gap gives an idea of the size of the “liquidity premium” investors are demanding. In theory, the bigger the bond issue, the more liquid it is, and at times of market stress it’s easier to sell at an acceptable price. Many large asset managers are showing a strong preference for large issues and issuers, and the market appears to be penalizing smaller names—not always fairly, in the team’s opinion.

Dispersion is Good News for Active Managers

When the gap between the top and bottom performers is wider, there’s more of a payoff for picking winners and avoiding losers, so credit research can create more of a competitive edge. Moreover, when the market is shunning small issues in favor of large ones, it’s more worthwhile to look for the gems among the smaller credits. Analyzing many small names is more labor intensive than focusing on a handful of big ones, so not every firm does it. But investors can potentially add value by gaining insights that their competitors don’t have. This kind of edge is harder to achieve when companies are already heavily researched, because all available information may already be in the price.

Some Bonds Are Cheap For A Reason; Others Offer Real Value

In some cases, the recent selloff is a necessary re-pricing of risk rather than a buy signal. For example, in the High Yield team’s view, spreads of many CCC names were previously not wide enough to compensate for the credit risk. In the same way, it’s appropriate that smaller issues should carry some liquidity premium. However, the team think that some companies have been unduly penalized by the repricing of credit and liquidity risk, and they think that value opportunities have begun to emerge, especially among some of the smaller names.

This material is distributed for informational purposes only. The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all MacKay Shields Portfolio Management[/entity] Teams. Any forward looking statements speak only as of the date they are made, and MacKay Shields LLC assumes no duty and does not undertake to update forward looking statements.[/entity]