Compensation for default risk in high yield at all-time lows
First State has sold all its high-yield corporate credit exposure because it believes the asset class’s valuations are rich and has a low spread against government bonds, according to Harman.
He said high-yield credit spreads are back to historic lows in the US and Europe having been compressed over the last few years, driven by few defaults and strong free cashflows.
Additionally, Harman said credit markets have been showing signs of fatigue recently as spreads have failed to follow equity market strength, with flows suggesting the market may be at a saturation point.
First State is also concerned that ETFs have dominated inflows which may ultimately leave high yield in “weaker and less committed hands”, he added.
“High yield has a much higher exposure to secularly and fundamentally-challenged sectors including retail, pharma and broadcasting whose spreads should continue to be under pressure and may ultimately leak into the broader market,” said Harman.
“By any measure, valuations remain on the richer end of the spectrum and fail to see catalysts to drive spreads significantly tighter. As a result, high yield now offers a much lower spread against government bonds we do not believe we’re being compensated for the risk in the asset class and have therefore sold all high yield corporate credit exposure.”
