PGIM Fixed Income’s Jonathan Butler sees a sweet spot for high yield bonds in today’s economic environment and highlights the benefits of active management.
After two years of uncertainty highlighted by rising inflation, aggressive interest rate hikes, and rate-cut expectations, PGIM Fixed Income's Jonathan Butler, Portfolio Manager of the PGIM Global High Yield Bond Fund, views today's environment as highly favourable for high yield bonds.
Despite elevated inflation and potentially slow growth—a scenario that PGIM Fixed Income calls ‘weakflation'—the global economy remains resilient, a soft landing is still possible, and recession odds are receding.
‘Our two most likely scenarios, weakflation and a soft landing, provide an exceptional backdrop for high yield fixed income,' Butler said.
Benefiting from historical yield trends
Driving Butler's optimism is the current elevated yield environment and the U.S. Federal Reserve's caution about cutting interest rates because inflation remains sticky. Bond yields peaked just above 8% in recent years when rates were rising. Historically, when starting yields fall in the 7-9% range, high yield fixed income has posted positive returns 86% of the time in the following year, with half of those periods generating double-digit gains.
The global high yield bond market rose 13% in 2023, outperforming investment-grade bonds by 4%. Although spreads are currently tight in both markets, the high yield sector benefits from a yield advantage and is continuing to outperform the investment-grade sector in 2024.
Expecting manageable defaults
Along with the positive returns, PGIM Fixed Income's high yield default outlook is muted because credit quality in the sector remains high. Defaults are expected to be contained at about 3.5% over the next 12 months, which is in line with the historical median level and far below the levels seen during the Global Financial Crisis of 2008-09 and the COVID-19 pandemic of 2020-21.
Butler said companies are doing a good job maintaining their liquidity, with just as many receiving debt upgrades from credit rating agencies as downgrades even at this late stage in the current economic cycle
‘The quality of the market is higher than ever,' Butler said.
Minimising refinancing risk
While high yield issuers seeking to refinance debt now at elevated interest rates may face increased credit risk, strong corporate fundamentals should minimize that liability, Butler said. In fact, refinancing activity may be low this year because most of the outstanding high yield debt maturing in 2024 and 2025 has already been refinanced.
Butler expects refinancing needs to peak in 2026 in Europe and in 2029 in the U.S. This activity should be manageable, he said, especially if private credit markets continue to offer a significant funding alternative.
‘As long as the economy remains resilient, the market is willing to fund companies at fairly high coupons,' Butler said.
Navigating nuances with an experienced active manager
Although the high yield bond outlook is bright, risks vary widely by credit rating, with significantly more risk and also potential reward available to investors in lower-rated debt. PGIM Fixed Income's deeply experience high yield bond team can help investors navigate these complexities by performing diligent research from the bottom up to identify relative value opportunities.
‘The high yield asset class offers attributes that should appeal to the varied needs of investors across the globe,' Butler said. ‘Active global strategies maintain the flexibility to capitalise on nuances that extend across regional markets.'
Strike the right balance with bonds at PGIMFunds.com.
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