High Yield Update – Fed to buy some fallen angels
Published 10th April 2020
David Crall, CEO and CIO, Nomura Corporate Research and Asset Management Inc.
On Thursday, April 9, the US Federal Reserve announced that they will begin purchasing some US high yield fallen angels and US high yield ETFs, an unprecedented extension of their willingness to support the US corporate debt markets. The Fed has said they will buy fallen angles (if they were rated at least BBB-/Baa3 as of March 22 and at least BB-/Ba3 at the time the facility makes a purchase) and high yield ETFs (which include all high yield ratings categories). We believe the entire US high yield market will benefit from these purchases, because when the Fed removes some bonds from the open market, capital “flows down the waterfall” to other bonds. This effect was clearly seen when the European Central Bank bought European investment grade bonds during 2016-2017 and European high yield spreads tightened significantly. In response, the US high yield market was up +3.16% on Thursday, extending the gains on the week to +5.28%, as measured by the ICE BofA US High Yield Constrained Index (HUC0).
Note that the Fed never bought corporate bonds before the recent fiscal stimulus package, the CARES Act, authorized the US Treasury to provide credit support to SPVs that the Fed would leverage. In its implementation of the CARES Act, we were not expecting the Fed to include high yield fallen angels or high yield ETFs, so this development was significant for the market. These high yield purchases will occur via the “Primary Market Corporate Credit Facility” and “Secondary Market Corporate Credit Facility” with a combined maximum size of $750 billion. The Fed’s announcement was part of a broader package of $2.3 trillion in loans to support the economy. Various SPVs will makes loans to entities including small and mid-size businesses, states, and municipalities, while also purchasing AAA CLOs, investment grade bonds, municipal bonds, and other assets. Federal Reserve Board Chair Jerome H. Powell said, “the Fed’s role is to provide as much relief and stability as we can during this period of constrained economic activity, and our actions today will help ensure that the eventual recovery is as vigorous as possible.”
This major Fed action comes at the same time that there is evidence that the rate of new Covid-19 infections may peak this week in the New York City metro area, and peak within the next two weeks in the US nationwide. Furthermore, Saudi Arabia and Russia have made progress toward reinstating the OPEC+ production cuts which provides a modest benefit to the oil sector. We are optimistic that a slow reopening of the economy may begin in June, and the economy will grow again in Q3. At the same time, we do acknowledge the risk of Covid-19 flare-ups will exist until a vaccine is developed. We are hopeful that better testing and better medicine will help us reopen. In the meantime, the economic data will be very bad, but monetary and fiscal stimulus will provide meaningful support for the economy and markets until the Covid-19 crisis has passed.
MTD through April 9, the US high yield market is up +2.72%, and the YTD returns are down -10.77%. As a reminder, the Bloomberg Barclays index family rebalanced to include fallen angels this month, while HUC0 and other ICE BofA indices did not rebalance, and accordingly, the Bloomberg Barclays US High Yield Index is outperforming HUC0 a bit, up +3.17% MTD. As mentioned in previous updates, we have endeavored to be a significant net buyer during the market sell-off over the last few weeks wherever possible in our funds and accounts. We have purchased large quantities of fallen angels across our portfolios during this period, though in general they have been tough to buy. We have also made many purchases in stronger credits and sectors, while making some value purchases among stressed sectors. Coupons and inflows in certain accounts provided some cash to invest, and meanwhile we have sold issuers where we expect liquidity problems, some energy positions, and some higher dollar securities in order to recirculate capital back into lower dollar price bonds.
This commentary was prepared by Nomura Corporate Research and Asset Management Inc. (NCRAM) and distributed by Nomura Asset Management U.K. Ltd and is for informational purposes only.
All information contained in this page is proprietary and confidential to NCRAM. All opinions and estimates included herein constitute NCRAM’s judgment, unless stated otherwise, as of this date and are subject to change without notice. There can be no assurance nor is there any guarantee, implied or otherwise, that opinions related to forecasts will be met. Certain information contained herein is obtained from various secondary sources that are believed to be reliable, however, NCRAM does not guarantee its accuracy and such information may be incomplete or condensed. Historical investment performance is no guarantee of future results. There is a risk of loss. Strategy performance references are based on gross of fees performance.
Certain information discussed may constitute forward-looking statements within the meaning of the U.S. federal securities laws. Although NCRAM believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, it can give no assurance that its expectations will be achieved. Forward-looking information is subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those projected.
There can be no assurance that historical forward returns will be realized, or met over any particular time horizon. Such returns do not take into account unanticipated material changes in the market and/or other economic conditions affecting investments.
This document is intended for the use of the person to whom it is delivered. Neither this document nor any part hereof may be reproduced, transmitted or redistributed without the prior written authorization of NCRAM. Further, this document is not to be construed as investment advice, or as an offer to buy or sell any security, or the solicitation of an offer to buy or sell any security. Any reproduction, transmittal or redistribution of its contents may constitute a violation of the U.S. federal securities laws.
An investment in high yield instruments involves special considerations and certain risks, including risk of default and price volatility, and such securities are regarded as being predominantly speculative as to the issuer’s ability to make payments of principal and interest.
The views and estimates expressed in this material represent the opinions of NCRAM and are subject to change without notice and are not intended as a forecast or guarantee of future results. Such opinions are statements of financial market trends based on current market conditions. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provided, and should not be relied upon as legal or tax advice.
Definitions of Indices
The ICE BofA US High Yield Constrained Index (HUC0) tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million. In addition, qualifying securities must have risk exposure to countries that are members of the FX-G10, Western Europe or territories of the US and Western Europe. The FX-G10 includes all Euro members, the US, Japan, the UK, Canada, Australia, New Zealand, Switzerland, Norway and Sweden. Original issue zero coupon bonds, 144a securities (both with and without registration rights), and pay-in-kind securities (including toggle notes) are included in the index. Callable perpetual securities are included provided they are at least one year from the first call date. Fixed-to-floating rate securities are included provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. Contingent capital securities (“cocos”) are excluded, but capital securities where conversion can be mandated by a regulatory authority, but which have no specified trigger, are included. Other hybrid capital securities, such as those issues that potentially convert into preference shares, those with both cumulative and non-cumulative coupon deferral provisions, and those with alternative coupon satisfaction mechanisms, are also included in the index. Securities issued or marketed primarily to retail investors, equity-linked securities, securities in legal default, hybrid securitized corporates, eurodollar bonds (USD securities not issued in the US domestic market), taxable and tax-exempt US municipal securities and DRD-eligible securities are excluded from the index. Index constituents are market capitalization weighted, provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face values of bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis. In the event there are fewer than 50 issuers in the Index, each is equally weighted and the face values of their respective bonds are increased or decreased on a pro-rata basis. Accrued interest is calculated assuming next-day settlement. Cash flows from bond payments that are received during the month are retained in the index until the end of the month and then are removed as part of the rebalancing. Cash does not earn any reinvestment income while it is held in the index. Information concerning constituent bond prices, timing and conventions is provided in the ICE BofA Bond Index Guide, which can be accessed on our public website (https://indices.theice.com), or by sending a request to firstname.lastname@example.org. The index is rebalanced on the last calendar day of the month, based on information available up to and including the third business day before the last business day of the month. New issues must settle on or before the calendar month end rebalancing date in order to qualify for the coming month. No changes are made to constituent holdings other than on month end rebalancing dates. Inception Date: December 31, 1996.
Source: ICE BofA, used with permission. ICE BofA is licensing the ICE BofA indices “as is,” makes no warranties regarding the same, does not guarantee the suitability, quality, accuracy, timeliness, and/or completeness of the ICE BofA indices or any data included in, related to, or derived therefrom, assumes no liability in connection with their use, and does not sponsor, endorse, or recommend NCRAM, or any of its products or services.
NAM UK is authorised and regulated by the Financial Conduct Authority (FCA) in the UK (registration no. 122703). NAM UK’s registered office is at 1 Angel Lane, London EC4R 3AB.
This document is for information purposes only. The evaluations presented in this document are based on information from various sources which are considered to be trustworthy by Nomura Asset Management Europe KVG mbH (collectively with other group companies „Nomura“). No guarantee is given in relation to the accuracy, completeness or currentness of the information, calculations and forecasts. Nomura does not accept liability for any loss, damage, cost or expense resulting from the use of or reliance on the document or other written or verbal notices and information by the recipient, including his/her executive bodies, employees, advisors or representatives or other entities. All forecasts and calculations (or statistical evaluations) are for explanatory purposes only. They are dependent upon evaluations, models and historical data, as well as interpretation by Nomura. The forecasts and calculations are based on subjective estimates and assumptions and do not constitute a prediction of future developments, and should not be construed to mean that the occurrence of one possible future result is more likely than the occurrence of another possible future result.
The content of this document is considered as minor non-monetary benefit in the meaning of MiFID II and not to be construed as legal, business or tax advice or as a recommendation of any kind. Distribution and duplication, even in parts for the purpose of forwarding the information to third parties is only permitted after obtaining the prior consent of Nomura Asset Management Europe KVG mbH.