Both US and euro high yield outperformed last year, and the firm is expecting a repeat, although with lower total returns. This scenario is particularly likely if rates rise, said the firm in its Investment Themes for 2014 note to clients.
“Spread product (high yield bonds) should continue to benefit from solid underlying credit fundamentals and a benign default environment. We anticipate that both US and European high yield total returns will likely be lower in 2014 compared to the previous year, albeit still outperforming other fixed income asset classes.”
Low defaults
Defaults in both Europe and the US should remain low in Muzinich’s view. “Refinancing risk remains low and balance sheets are solid. The low default rate of the last couple of years should continue and, as such, we are expecting defaults in Europe and the US to stay below 2%, excluding any potential impact of a large pre-crisis leveraged buyout (LBO) default which has been rumoured in press articles.”
Demand for credit will remain in place for high yield and floating rate investments, which will both see net inflows, said the firm. “Whether high yield inflows keep up with leveraged loan flows will depend on US interest rate moves, in other words any changes will likely see inflows into loans outflows from high yield. If rates do not move significantly we expect high yield to see higher flows.
Muzinich also expects the long-term trend of declining US Treasury yields will come to an end this year. Short-term rates will remain low, even with an improving economy.
Fewer loans
Increased regulatory oversight of US leveraged loans may result in a reduction in the number of banks willing to underwrite loans. This, said Muzinich, may lead to increased cost of underwriting, causing companies to rethink their loan/bond allocations within their capital structures.
“While we continue to analyse and understand large macro developments, we remain focused on bottom-up, corporate credit analysis. Company fundamentals in general remain very solid. We continue to believe that duration risk outweighs credit risk. We target mid-single digit returns in 2014,” Muzinich concluded.
