A big rebound may be unlikely after the 2022 markets debacle, but asset managers are still optimistic about high-yield bonds in 2023.
The first half of the year will witness many companies grappling with declining profits amid weak economic growth and inflationary pressures. However, Kyle Kloc, senior portfolio manager of Zurich-based Fisch Asset Management, envisages change. “We expect spreads to widen in the first six months before narrowing again in the second half of the year,” said Kloc.
While high yield issuers still look to be in a good position, the situation could deteriorate to a certain extent. “Although debt is unlikely to increase, a drop in earnings before interest, taxes, depreciation and amortization will lead to a higher debt ratio. Besides, the rise in interest costs will impact free cash flow. We expect default rates to climb this year – probably to around 4% in the US and Europe,” said Kloc.
In emerging markets, on the other hand, default rates should remain around 10%, thanks to the Chinese real estate sector. “A sharp rise in default rates does not appear to be on the cards, as the number of bonds maturing in 2023 is still relatively low,” said Kloc, highlighting the inability to repay or refinance debts reaching maturity as a cause of default.
The euro high yield market is more defensive because of its higher average rating and lower duration, Kloc pointed out. “The US market is shrinking and better able to cushion the impact of potential outflows. We prefer euro high yield bonds, as they offer investors a higher spread than their US peers for the same rating.
2023 might witness an increase in the number of rising stars and fallen angels—or at least remain at a high level. “Further upgrades in fallen angels are likely in 2023 – particularly in the energy sector, but also in the case of a major automotive company. This would lead to a reduction in the weighting of the energy sector within the index, even though it is likely to remain the largest sector due to a significant gap in relation to the second-largest one,” said Kloc. A rise in the number of fallen angels owing to a decline in earnings in the wake of economic gloom and high-interest rates and spreads are also estimated.
Disparities at an individual stock level are unavoidable as the fundamental outlook for individual companies continues to diverge. Nonetheless, Kloc expressed confidence about technical factors easing the challenges of security selection.
With interest rates at a more ‘reasonable’ level, monetary policy should help the high-yield market to gradually revert to levels before the global financial crisis.
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