| “Markets will continue to present challenges, but our experience reinforces a simple principle: focusing on income, maintaining credit discipline and avoiding unrewarded risks can provide a strong foundation for compounding returns over time.” |  |
A decade of delivery
A decade ago, Insight worked with BNY to launch a pooled version of its global short-dated high yield bond strategy. The philosophy was straightforward: investors should not necessarily have to take significant interest-rate risk or sacrifice credit quality to access the income potential available from high yield bonds.
A great deal has changed since then. Investors have experienced negative interest rates, the COVID-19 pandemic, a sharp global tightening cycle, inflation shocks, regional banking stress and heightened geopolitical uncertainty. Yet we believe many of the characteristics that supported global short-dated high yield bonds over the past decade remain firmly in place.
Indeed, the starting point has arguably improved in some important respects. Yields in global short-dated high yield markets are higher than they were ten years ago, while the average credit quality of the wider high yield market has increased significantly. In our view, this provides a potentially attractive backdrop for an approach focused on income, disciplined credit selection and avoiding unrewarded risks.
Why consider short-dated high yield bonds?
One of the defining characteristics of short-dated high yield bonds is their relatively low sensitivity to changes in long-term interest rates and credit spreads. When yields rise, shorter-dated securities will typically experience a smaller price impact than equivalent longer-dated bonds. Historically, this has allowed the asset class to generate attractive long-term returns while experiencing lower volatility than both the wider high yield market and global equities.
Short maturities can also make credit analysis more focused. The further investors look into the future, the greater the uncertainty surrounding a company’s business prospects and its ability to repay its debt. Insight's approach therefore focuses not simply on buying bonds with short maturities, but on identifying companies with visible cashflows and a clear pathway to repayment over a roughly two-year investment horizon.
Putting income at the centre of returns
Reducing interest-rate sensitivity also places greater emphasis on income. Rather than depending on falling yields to generate capital gains, investors can derive a larger proportion of returns from the contractual cashflows generated by the underlying bonds. Over time, this can help total returns gravitate towards the running yield of the asset class.
The potential effect becomes particularly significant when that income is reinvested. Compounding allows investors to earn returns not only on their original investment, but also on the income accumulated along the way. After an extended period of exceptionally low bond yields, we believe the potential contribution from reinvested income may be underappreciated.
A global opportunity set
High yield is not a single, homogeneous market. The US, European and emerging market high yield universes differ in their sector composition, credit quality and sensitivity to economic and monetary conditions. These differences have contributed to significant regional variations in yields and returns over time.
For active global high yield investors, this can create opportunities. Rather than being tied to a single region, managers can seek to allocate towards markets, sectors and securities where they believe investors are being adequately compensated for the risks they are taking.
The same principle applies at the issuer level. Although aggregate corporate fundamentals remain encouraging, the paper highlights significant variation beneath the surface. Spread dispersion remains considerably higher in high yield than in investment grade credit, potentially creating opportunities to identify issuers whose fundamentals are stronger than their valuations imply and avoid those where the risks appear insufficiently priced.
A high yield market that has evolved
The composition of the global high yield market has changed materially. BB-rated securities now account for a far larger proportion of the market than in the past.
Meanwhile, companies have actively managed their maturity profiles, leaving relatively few bonds due to mature over the immediate two-year horizon. We believe higher absolute yields, improving credit quality and limited near-term maturities together provide a supportive technical backdrop for the asset class.
Active management and credit discipline remain critical
Higher yields alone do not remove the risks associated with high yield investing. Avoiding defaults remains fundamental to capturing the income available from the asset class.
Insight's global short-dated high yield approach therefore focuses on businesses with visible cashflows and identifiable milestones, supported by ongoing monitoring of management's business plan.
Active management can potentially uncover other sources of return as well. One distinctive feature of the high yield market is the ability of issuers to redeem bonds before maturity at a premium to their face value. Identifying companies approaching important milestones in their business plans can potentially help investors anticipate these calls and capture an additional source of return.
The next decade starts here
Ten years after the launch of the pooled version of Insight's global short-dated high yield strategy, we believe the investment philosophy remains relevant: seek to capture attractive income while limiting exposure to risks for which investors may not be adequately rewarded.
The combination of shorter maturities, higher starting yields, improving credit quality, limited near-term maturities and significant dispersion between issuers and regions creates, in our view, a potentially favourable environment for disciplined active management.
In A decade of delivery: Ten reasons global short-dated high yield bonds still stand out, Insight's investment team explores ten characteristics of the asset class and considers why they could continue to matter for investors in the years ahead.
