2023 was a year that high-yield bond investors won’t soon forget. It was a period marked by a spirited comeback, with global high-yield bonds extending their rally, clocking a 3.1% gain in Q4 and culminating in a robust 9.6% total return for the year, as per the ICE BofA Global High Yield Constrained Index.
This performance starkly contrasts with 2022’s 7.5% dip, showcasing a remarkable turnaround. Investors, buoyed by the anticipation of Federal Reserve rate cuts in 2024 and a potential soft landing in the U.S. economy, propelled these bonds to new heights. European high-yield bonds outdid their American counterparts with a 12% gain in euro terms.
But it wasn’t all smooth sailing. The final quarter of 2023 saw a swift decline in yields - European high-yield bonds plummeted from 7.9% in October to about 6.1% at year’s end. U.S. yields followed suit, dropping from 9.5% to 7.4%. This dip was mirrored in the ICE BofA US High Yield Index Option-Adjusted Spread, which closed the year at 339 basis points, well below the tumultuous heights of 522 basis points during the SVB and Credit Suisse crises.
Are expectations running too high? Credit investors seem unfazed for now. Even the spread on lower-rated U.S. high-yield bonds (CCC and below) fell to 902 basis points by the end of 2023, a substantial drop from November’s 1,057 basis points. The general consensus among investors seems to be that most companies won’t need to re-enter the market until 2025-2026. Yet, there’s an underlying sentiment that a soft landing might already be priced in, potentially dampening short-term upside potential.
Looking ahead, the divergent forecasts for 2024 hinge heavily on the economic scenarios painted by strategists and economists. A recession typically means more defaults, hurting the category’s returns, whereas a soft landing paired with rate cuts is the dream scenario for bondholders, offering attractive income and capital appreciation.
Neutral stance
BlackRock’s Investment Institute took a neutral stance on high-yield bonds in September, wary of recession risks. However, the tight spreads haven’t deterred them from upgrading their outlook, now favoring European bonds for their enticing yields. Capital Group notes that high-yield bonds historically perform well as long as economic growth remains positive, with the income component bolstering returns even as state bond spreads widen. Robeco, in its report “Party like it’s the 1990s,” advises caution, reminding us that central bank tightening cycles often lead to recession, with the mid-90s being a rare exception – an exception that the market seems to be banking on.
In our weekly Top 5, we spotlight the standout performers in global high-yield bonds of 2023. Topping the list is UBAM Global High Yield Solution, managed by Philippe Gräub and Bram ten Kate of Union Bancaire Privée. This fund, notable for its use of Credit Default Swaps (CDS) and trading in the popular iTraxx Crossover index, has consistently ranked in the top decile over 1-, 3-, and 5-year periods.
Another strong performer is the M&G (Lux) Global Floating Rate High Yield Fund, managed by James Tomlins. Its focus on sectors less sensitive to economic cycles and inflation, combined with a higher allocation to floating-rate bonds, has helped it maintain top-tier performance.
As we venture into 2024, the overarching narrative is one of cautious optimism, tempered by the knowledge that the market’s current pricing might be overestimating the likelihood of a smooth economic trajectory. For fund managers and asset allocators, the challenge will be navigating this complex, ever-changing landscape, balancing risk and reward in a sector known for its dynamism.
Top 5 High Yield Bond funds in 2023, as per NL classification
Thomas De Fauw is a manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds on the basis of quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.