National Conference on Public Employee Retirement Systems

The Voice for Public Pensions


2024 Outlook: What’s Next for High Yield?

By: Brian Pacheco, Barings

What will 2024 hold for high yield investors? Brian Pacheco of Barings weighs in on the opportunities and risks ahead.

2024 Outlook: What’s Next for High Yield?
This is an excerpt from NCPERS Winter 2024 issue of PERSist, originally published January 16, 2024.
Against a backdrop of heightened uncertainty, what has surprised you most about high yield over the past year?
One of the biggest surprises this year has been the strong performance across the high yield bond and loan markets. While that was partly due to high yield's shorter duration/lower interest rate sensitivity, it was also a result of the lack of negative catalysts. As we expected, the wave of defaults that some were anticipating at the start of the year have not transpired. At the same time, downgrades have been manageable. The big question, of course, is can the strength continue if the macro picture starts to worsen?
What is your view of the credit quality in high yield bonds and loans?
With 2023 having been a relatively benign year for defaults, some analysts are still predicting draconian default rates and widespread investor losses in the next 12 to 18 months. However, that's not our base case scenario for a few key reasons. First, if a recession or a sharp slowdown were to occur, it would be one of the most anticipated downturns in history. Since markets are forward-looking, they have already priced in a downturn such that most credits likely to default over the next 12 to 18 months are already trading at steep discounts to par—and the high yields currently on offer should help absorb any defaults that do materialize.
At the same time, the quality of the high yield market has improved significantly over the last decade. BBs, for example, now represent around half of the market, up from 40% a decade ago. CCCs, which have the highest risk of default, now account for only 10% of the market versus more than 20% after the financial crisis.1
Looking ahead over the next year, what areas look most attractive?
With yields across the high yield market remaining at elevated levels versus much of the period following the Global Financial Crisis, there is no need to “stretch for yield" by taking on additional credit risk. In particular, we see select opportunities in high-spread, yield-to-takeout trades, in which there are near- to medium-term maturities and where the borrower has liquidity levers or secured capacity—essentially, multiple ways to refinance. In BBs and high-quality single Bs, we look for catalysts for spread tightening, which could be earnings momentum or upgrade potential due to improving fundamentals. Meanwhile, in the loans market, there is considerable carry.
What do you see as the biggest risks to high yield today and tomorrow?
While we're not too concerned about the high yield market overall given the default rate math and elevated yields, what's different about this cycle is the poor creditor protection in recent-vintage loans and how companies and sponsors are finding creative ways to exploit gaps. Being caught on the wrong side of liability management worries us, and while there are ways to mitigate the risks, none is foolproof.
At the same time, there is a risk in sitting on the sidelines and trying to time things perfectly. There is simply too much income available right now to wait because buying opportunities like this don't typically last very long. But given the uncertainties on the horizon, we believe that a bottom-up approach to investing remains crucial to both avoiding additional downside and identifying issuers that can withstand the challenges ahead.
About the author: Brian Pacheco, Portfolio Manager, Global High Yield, is a member of Barings' U.S. High Yield Investments Group, responsible for portfolio management for multi-asset credit, high yield bond and senior secured loan strategies. Prior to his current role, Brian was the sector head for commodities and provided lead research coverage of the exploration and production and oilfield services segments within the energy industry. Brian has worked in the financial sector since 2000. Prior to joining Barings in 2018, Brian held senior investment analyst roles at UBS O'Connor LLC, Bardin Hill Investment Partners and Chicago Fundamental Investment Partners. Before transitioning to the buy-side, Brian was employed by J.P. Morgan in both leveraged finance and industry coverage. Brian is a member of the CFA Institute and holds a BBA in Finance from the University of Massachusetts at Amherst and an MBA from the University of Chicago Booth School of Business.
[1] Source: Bank of America. As of September 29, 2023.


There have been no comments made on this article. Why not be the first and add your own comment using the form below.

Leave a comment

Please complete the form below to submit a comment on this article. A valid email address is required to submit a comment though it will not be displayed on the site.

HTML has been disabled but if you wish to add any hyperlinks or text formatting you can use any of the following codes: [B]bold text[/B], [I]italic text[/I], [U]underlined text[/U], [S]strike through text[/S], [URL][/URL], [URL=http//]your text[/URL]