However, it is likely to be closer to the mid-point of 2021 before vaccines have reached enough of the global population for any true normality to return to our lives. While the vaccine is a significant boost, unemployment is likely to remain elevated for some time. Government and central banks' support is likely to persist for a period measured in years, rather than months.
In addition to the vaccine, Joe Biden’s election as President of the United States provided a boost to markets. Our take is that a more predictable presence in the White House – alongside a balanced Senate – is a positive outcome. In addition, the reduced chance of large fiscal packages limits the immediate likelihood of significant inflation in the United States. Thus, the Federal Reserve will be able to keep monetary conditions loose.
High yield has all the ingredients to outperform in 2021
A continued looseness of monetary policy should prove supportive to the high yield market in 2021. We have seen in the past that major monetary policy or announcements of quantitative easing take time to trickle down to the high yield market – but often have a very significant impact when they do.
The blue line on the chart below shows the performance of high yield relative to investment-grade markets from the announcement of the European Central Bank’s Corporate Sector Purchase Programme in 2016 –the first time the central bank bought corporate bonds. During the first period, high yield and investment grade spreads moved in lockstep. After a period of around 200 days, high-yield bonds began to outperform investment grade materially. This makes sense. The initial impact was on the investment grade market (the ECB was exclusively buying investment-grade bonds). It took time for buyers to become comfortable with moving into the high yield market to achieve attractive returns.
HY/IG spread ratios following major central bank policy announcements
Source : Bloomberg, BofAMerrill Lynch as at 31/10/2020
As well as this ‘portfolio channel’ effect, which is valuation-driven, investors will wait to see positive developments before adding more credit risk. In March 2020, the US Federal Reserve announced that it would – as the European Central Bank had done in 2016 – buy corporate bonds for the first time. The second line shows the same relationship for US high yield and investment grade spreads since this announcement. As the chart shows, we are approaching the period in which high yield – if it follows the same trajectory as in 2016, which we believe it will – begins to significantly outperform investment grade. Ultimately, actions by the central banks have already had a massive impact on the government bond and investment grade corporate markets.
Attractive yields will draw in investors
High yield is the last market that still offers elevated spreads. It is the most attractive place for capital that has been pushed out of low yields in other parts of the bond markets. Alongside this, the resilience of corporate earnings (and hence, a reduction in credit risk) surprised many during the Q3 2020 reporting season. It is this resilience, alongside the ‘portfolio channel’, which we feel supports the substantial opportunity within high yield.
Dislocations in prices within high-yield present opportunities
Alongside these global factors, we have to consider the elements that are more specific to high yield.
Currently, the spread over government bonds on the global high yield bond index is approximately 25% above where it began 2020. However, this figure masks a great deal of dispersion – the telecommunications sector has a credit spread that is 15% lower than it was at the beginning of 2020. By contrast, the banking sector has a credit spread 35% higher. Index-led and passive investors in high yield will have large allocations to telecommunications – but we believe this part of the market is fully valued.
For strategies such as ours – which are highly active and agnostic to the underlying index – the dispersion in the market provides a rich hunting ground for alternative opportunities. We expect to continue to take advantage of these in 2021.
High-yield trading at a discount to the start of 2020 – but this masks a large degree of dispersion
Source: ICE BoAML Global High Yield Constrained Index as at 12 November 2020
Inefficient pricing around ESG could be another opportunity
Another approach which appears to still provide plentiful opportunities for outperformance is ESG. The market can be inefficient at deducing and adjusting to ‘changes in regime’. In a number of areas within the high yield market – notably the energy sector – a change is occurring that we think the market is failing to reflect. The transition away from fossil fuels is something that we believe is priced inadequately by much of the market.
This is one of the key reasons that our funds have around half the carbon intensity of the wider high yield market – and an area where we believe we are considerably more resilient than other strategies.
Artemis' high-yield funds are considerably less carbon-intensive than the market
Source : MSCI, Artemis as at 30/11/2020
The combination of continued support from central banks, more predictable US politics, an economic recovery boosted by vaccines, and mispricing in markets provides a rich opportunity set for the Artemis Global High Yield funds over 2021. With your support, we look forward to the year ahead.
- High yield likely to benefit from significant support from central banks – we believe that the unprecedented actions from central banks in 2020 will continue to have a positive impact on fixed income. And high yield is approaching the point where its relatively higher yields should lead to outperformance.
- Roll-out of vaccines will improve visibility of the economic recovery – the news of successful vaccines provides a path out of the current situation, which will be very positive for the global economy. The resumption of consumer spending and investment delayed in 2020 should provide a further boost to growth.
- Plentiful opportunities for investors who take an approach that is active, high-conviction and index-agnostic – the high yield market is full of inefficiencies, and the level of dispersion within the market provides us with plentiful opportunities for outperformance in 2021.
- Roll-out of vaccines unlikely to be immediate – it will take time to produce significant quantities of vaccines and to roll them out to the general population. The economic recovery will not be immediate. However, the visibility of that ‘reopening’ is likely to encourage investors.
- Inflationary worries may rise – many commentators have raised concerns of inflation due to the significant fiscal and monetary programmes put in place in 2020. We doubt that these will be enough to generate sufficient inflationary pressure to offset the structural deflationary forces we have seen over the past decade. We had anticipated a small amount of inflation in 2020 had coronavirus not shut down the global economy. And any unexpected inflationary pressures in 2021 would be negative for fixed income. While high yield is the least exposed part of bond market to this, it would be likely to have some negative impact on fixed income investment in general.
- Defaults may exceed our expectations – we believe that the peak for defaults occurred in the summer of 2020. While some further defaults are expected (and largely priced in), any further uptick could threaten returns. This scenario is unlikely, given the economic recovery expected in 2021. But defaults are always something we, as high yield investors, need to be wary of.