With yields at almost 10% p.a., US HY offers investors a very solid buffer during adverse market development. This can be illustrated by a hypothetical multi-factor 12-month scenario, stressing the projected total return with a simultaneous risk-free rate curve steepening (-25bps on short and +100bps on long maturities), credit spreads widening (+200bps) and elevated realized defaults (5% default rate with 40% recovery).
Given shorter duration (i.e. 3.5 years), HY markets are less sensitive to risk-free rate moves and curve steepening in particular. Hence a very small positive impact of +0.8%. In the next step, realized defaults (-3%), combined with credit spreads widening (-6.9%) on the remaining non-defaulted bonds reduce the scenario returns from 9.8% to 0.7%. To put this hypothetical stressed return in context, the scenario-based spreads widened by ~50% and defaults more than doubled from current levels.
While overall HY bond market remains robust by number of metrics (e.g. portion of BB-rated credits is among the highest historically), the increasing dispersion requires active management, dynamically avoiding weakening bond issuers.
Read more in our Alternative Credit Letter
