You may have noticed over the past several weeks that in addition to the great economic insights posts here on the Institutional Investor section of The Principal Blog, there have been some guest contributors. Several investment professionals from Principal Global Fixed Income have been writing posts that delve into their areas of expertise. You’ve seen posts on managing volatility and tail risk from Derek White, the head of risk management. You’ve read about bank loan strategies from Mark Cernicky, product specialist. You’ve learned about yields on Japanese government bonds from our global strategist, Seema Shah. And you’ve read about 10 concrete concepts to researching high yield from Phelps Hoyt, our head of high yield research.
I’m delighted to announce that because of the positive response we’ve received on the fixed income blog posts, we’ll be expanding our Institutional Investor section to include regular posts from the fixed income team! Read more
There’s a lot of money flowing into bank loans. As of May 17th, bank loan funds have had 48 consecutive weeks of inflows; year-to-date inflows have totaled a record US$24 billion. Compare that with year-to-date inflows of US$2.6 billion for high yield bonds. In fact, over the past 16 weeks, bank loan funds have averaged over US$800 million per week, and six of those weeks have represented the highest flows ever. A recent Wall Street Journal article covered the topic (paywall). Bank loans are a high yield asset class, which draws a natural comparison to high yield bonds. Consider this – despite the overwhelming positive demand for bank loans, year to date, high yield bonds have outperformed bank loans by over 2% (5.51% for the JP Morgan US High Yield Index vs. 3.26% JP Morgan Leveraged Loan Index). To me, this represents both caution and opportunity. Don’t assume that bank loans, as an asset class will outperform high yield bonds. That said, bank loans can still be a positive contributor if you understand what makes the asset class unique and if you understand what makes one issuer better than another. Read more
Last week, I introduced the idea of ten concrete concepts that our high yield research team uses to help summarize the many interacting factors and variables that make high yield a unique and challenging asset class. In my previous blog post, I covered the first five: cash flow, capital, cushion, cyclicality, and competition. To finish up this thought, here are the last five:
- Cost Structure – A company can’t provide products and services to customers without incurring some costs. Within a particular sector, many companies face similar cost pressures, but not always. For instance, there is a currently great disparity between the cost of natural gas in Europe (high prices) and in the United States (low). This has created a tremendous opportunity for companies in the chemical sector that use natural gas as an input to their production process.
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Investors looking for yield face a challenge in the current market environment. With many of the world’s major central banks engaging in quantitative easing, sovereign debt yields are at or near historic lows. That drives fixed income investors to look at bonds with lower credit ratings, specifically non-investment grade bonds, or more appropriately, high yield. That demand is being met by new supply. In fact, March saw U.S. high yield volume reach US$34.9 billion. That’s the highest monthly output since October of last year. However, high yield isn’t an asset class where an investor should just wade in and buy up whatever supply hits the street. Investing in high yield requires rigorous research, and as the head of Principal Global Fixed Income’s high yield research, I’ve found that it’s useful to keep in mind ten concepts that help summarize the many factors and variables that interact to make high yield unique and challenging. Here are the first five:
- Cash Flow – Cash flow is important to everyone, but it’s critical in high yield investing. We look at cash flow as the life blood of a company. It is what is left after a company sells its products and pays the costs to produce and sell those goods. Read more