Corporate credit has been behaving in an interesting way to start 2019. While lower rated credits have generated higher returns, with high yield outperforming investment grade and CCC rated securities outperforming BB and B rated securities, a deeper analysis reveals that investors may not be allocating as aggressively as they seem. Lower rated and longer duration credit spreads have not recovered as much as higher quality and shorter duration securities. Within high yield, BB, B, and CCC rated spreads have tightened by 41%, 31%, and 20%, respectively. The gap is even more noticeable on the front end of the curve where 1-5 BB, 1-5 B, 1-5 CCC spreads have tightened YTD by 50%, 33%, and 22%, respectively. Analyzing relative returns reveals a similar trend within the high yield market. While high yield has outperformed treasury securities YTD, they have not returned to the prior high from last year.
This is also true when comparing the different credit ratings within high yield to each other.
This is made even more confounding by the fact that despite the lack of progress in relative performance, the relative valuations between high yield credit ratings and BBB rated credits are below average.
Coinciding with the lack of performance recovery and the unattractive valuations (or possibly helping to explain them) is the shift in liquidity. Primary dealer positioning and trading in corporate credit, especially high yield, has declined significantly in the last two years while trading volume is at a new low.
Also, the lack of performance recovery in lower rated high yield securities has occurred at a time when fund inflows (mutual fund and ETFs) have failed to reverse the large outflows of Q4 2018.
At the same time, inflows into investment grade securities have been strong to start 2019.
This analysis lends support our decision to lower the overall risk profile of fixed income portfolios, reducing corporate related credit risk, and increasing liquidity.
Rank Dawson, CFA
Vice President, Strategic Planning
Boyd Watterson Asset Management, LLC
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.