Following two quarters where pandemic newsflow completely reshaped financial markets, we take a look at the high-yield landscape, asking Andrzej what’s happened, why, and what investors should be on the lookout for in the second half of 2020.
High-yield bonds often deliver strong returns following a period of crisis – why is that and will it happen in the wake of COVID-19?
Due to a higher-risk nature of its constituents (including the greater risk of default), the high-yield (HY) universe typically experiences the most pronounced price dislocation during sell-offs. Similarly, as markets subsequently rebound, HY is typically the asset class to rally back the most as fears abate.
Looking at global indices this year, HY declined by over 20% from the February highs to the March lows – the investment-grade (IG) universe decline was in low teens. From the lowest point in March, HY then rebounded almost 25%, while IG rose by around 20%.
One could argue that the rebound gap should have been even greater, however, IG gained additional support from the rally in government bond yields and the fact that many central bank bond purchase programmes directly benefitted IG issuers.
Looking at current valuations, we’re still trading at wider spread levels compared to earlier this year, but valuations are nowhere near the ‘crisis’ levels seen in March.
As for history repeating itself, if we have another sell-off in the autumn driven by a second wave of COVID-19 or any other market-moving factor, we’d expect the sell-off to be less painful, as fiscal and monetary policy authorities have put a robust market backstop in place. Additionally, after experiencing a powerful rebound during the spring, investors are likely to think twice before dumping bonds in an indiscriminate fashion.