After gaining 13.5% in 2023, as measured by the ICE BofA US High Yield Constrained Index, the high yield (HY) market has had a quiet start to 2024. The market had a gain of 0.3% through the first two months, as spreads have mostly absorbed the move to higher interest rates. Compared to the first two months of 2022 and 2023, HY companies have issued more bonds due to lower borrowing costs and open capital markets. Default rates over the past year are below 2%, and modest distressed debt levels suggest a stable environment. Bonds rated CCC are outperforming higher-rated peers, continuing the trend of 2023
Outlook and Challenges
The high yield market has significantly tightened since October 2023 as per the ICE BofA US High Yield Constrained Index. Bonds rated BB and single-B now have narrower spreads compared to their historical trading patterns, while CCC-rated bonds are closer to their typical trading levels. Any further tightening in spreads is likely to come from the CCC segment. Even though CCC bonds make up only 13% of the market (less than the usual 17%), their performance will heavily influence overall returns due to current valuations. Skilled active managers who pick bonds wisely in this segment should do well, but passive investment in the CCC index may lead to some credit losses.
In the high yield market, there have been eight years with negative returns; seven of them were followed by years with double-digit gains. The year after the strong performance typically sees stable returns. In 2024, starting with a high yield near 8% and a duration of 3.3 (compared to 4.5 in 2022), investors can expect steady returns with relatively low sensitivity to interest rate changes. We at J.P. Morgan anticipate spreads to stay within a certain range throughout the year, and a modest default rate of around 2–2.5%, resulting in a projected return of 6-8% for 2024.
Investment Opportunities
Given the gap between high and low credit quality high yield bonds, we believe there are select opportunities for managers to outperform within CCC-rated bonds. These situations can be complex and carry risk, but they offer double-digit yields, much higher than the market average of nearly 8%. HY has a break-even of more than 230 basis points, which means they can absorb more than a 2% move higher in interest rates and still generate a positive return. Moreover, many high yield bonds are priced below their face value, so there's a chance they could go up in price if they're paid off early or if a better-rated company buys the company.
Fund Strategy
The investment strategy is driven by a fundamental research and bottom-up security selection, with no quality nor duration bias over time. The strategy seeks to identify undervalued securities in the marketplace through fundamental research and relative value analysis, with an emphasis on downside protection.
This flexible approach allows the strategy to shift exposures in response to changing market conditions and is designed to generate excess returns in both up-and-down markets.
