Exhibit 87: High Yield Par-Weighted Interest Coverage Ratio Interest coverage today stands near all-time highs,
unlike the pre-crisis period.
4
3
2
1
0 SH ae woe Se ees 8888 SEsesese8 8 RR ERR SRE ES
Data through 03 2016.
Source: Investment Strategy Group, Barclays.
Coverage Ratio 5
Exhibit 88: Characteristics of US High
Yield Issuance
Today's high yield universe is much healthier than the pre-crisis cohort.
Use of New Issuance Proceeds (%) 60 2006-07 Average ™ 2015-16 Average
50 48
40
LBO and M&A
Low-Rated Companies Aggressive Securities
(PIK/Toggle Bonds)
Data as of December 31, 2016. Source: Investment Strategy Group, JP Morgan.
Of course, a more constructive view of high yield fundamentals does not necessarily suggest robust returns. In high yield bonds, today’s below- average spreads already reflect our subdued default expectations and are less likely to offset any further increase in rates. We thus expect returns of around 4% in the year ahead. Although high yield energy is likely to generate similar gains, the potential upside is more significant given wider starting spreads and the potential for distressed bonds to pull to par amid higher oil prices. Finally, with a 5% return, bank loans should perform marginally better than bonds, reflecting their attractive 0.25-year duration and continued investor demand for floating rates—a feature that is back in vogue now that 3-month LIBOR is almost above the 1% LIBOR floor that more than 90% of bank loans possess.
While these returns may pale in comparison to those of last year, they remain attractive relative to investment grade fixed income, where we expect rising rates to generate lower returns. Even if rates stagnate while US growth remains positive, the default-adjusted return in high yield should still trump high-quality bonds. Said differently, US corporate high yield credit remains a better house in a bad fixed income neighborhood, supporting our modest overweight recommendation.
Exhibit 89: High Yield Credit Performance During Periods of Rising Rates
High yield has historically outperformed investment grade bonds during episodes of rising rates.
Average Return (%)} % of Time Positive
5 @ Average Total Return During 100 Episodes of Rising Rates* 4 © % of Time Positive (Right) 75 3 2 50 1 0 25 -1 2 0 Inv. Grade Fixed High Yield High Yield Bank Loans Bank Loans Income (IGFI) Less IGFI Return Less IGFI Return
Data as of December 31, 2016. Source: Investment Strategy Group, Barclays, Credit Suisse. * Defined as 5-year Treasury yield rising more than 70 basis points over a 3-month period.
European Bonds
Unlike their US counterparts, European fixed income markets did not forfeit all their gains by the end of last year. This served as a poignant reminder of how divergent monetary policies can shape returns. Three ECB actions in March drove this robust relative performance. First, the ECB reversed its prior commitment to avoid
Outlook | Investment Strategy Group 71
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