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High yield bonds: more attractive than leveraged loans?

Guest blog: Schroders weigh in with their latest outlook for high yield bonds

There are times when the leveraged loan market can provide attractive investment opportunities, but loans are unlikely to be able to achieve investors’ goals in the current market environment, in our view. Instead, we believe that investors should consider maintaining exposure to high yield bonds.

Before making a final decision about the asset allocation between high yield bonds and leveraged loans, investors should evaluate the fundamentals, technicals and valuations provided by each market.

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Sensitivity to interest rates 

While many investors consider buying loans because they are concerned about rising short-term rates, the fact is that high yield bonds have historically posted strong returns and have done better than other fixed income alternatives during periods of rising rates.

There are two main reasons for this: (1) greater coupon income tends to mitigate price erosion and (2) periods of rising rates tend to correspond with an improving economic environment, rising corporate profits and stronger fundamentals, all of which lead to lower default rate expectations, which are positive for the high yield sector.

Recovery rates in the event of default 

As mentioned above, one of the reasons why investors prefer loans to bonds is because of their higher position in the capital structure. However, if expectations for defaults are low, as they are today, then investors should not be as focused or concerned about how they would fare in the event of a default.

Global default rates have fallen to 3.3% for the 12-month period ending May 31, 2017. This is well below the long-term average of 4.4% and below the peak reached last year of 4.8% where 80% of the defaults were in the commodity-related sectors.

The credit quality for the overall high yield issuer universe has actually been improving over the last year and we believe that this trend is set to continue in the coming year.

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Important information For professional advisers only. This material is not suitable for retail clients.  Past performance is not a guide to future performance and may not be repeated.  The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.  Schroders has expressed its own views and these may change.  The sectors, regions and companies mentioned in this article are for illustrative purposes and not a recommendation to buy or sell. The data contained in this document has been sourced by Schroders and should be independently verified before further publication or use. The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue.  Our forecasts are based on our own assumptions which may change.  We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts.  Forecasts and assumptions may be affected by external economic or other factors. Issued in February 2017 by Schroder Unit Trusts Limited, 31 Gresham Street, London EC2V 7QA. Registered No: 4191730 England. Authorised and regulated by the Financial Conduct Authority

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