INSTITUTIONAL INVESTOR COMMENTARY IG • HY
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ABS
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CMBS
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RMBS
JANUARY 2013
High Yield and Bank Loan Outlook INVESTMENT PROFESSIONALS B. SCOTT MINERD Chief Investment Officer ANTHONY D. MINELLA, CFA Co-Head of Corporate Credit MICHAEL P. DAMASO Co-Head of Corporate Credit JEFFREY B. ABRAMS Senior Managing Director, Portfolio Manager KEVIN H. GUNDERSEN, CFA Managing Director, Portfolio Manager KELECHI OGBUNAMIRI Associate, Investment Research
As we kick off 2013, there is a noticeably cautious tenor surrounding the leveraged credit market. Although 2012 saw impressive returns in the high yield bond and leveraged loan markets of 14.7 and 9.4 percent, respectively, few are expecting a repeat of this performance. Since December 2008, the high yield bond and leveraged loan markets have recorded annualized average returns of 22 and 14 percent, respectively, but record high prices, historically low yields, and gradually deteriorating fundamentals have tempered forward expectations with forecasts calling for single digit returns. Muted optimism aside, the leveraged credit market remains the primary destination of choice for investors seeking yield in the fixed income market. Despite leverage stealthily ticking up towards post-recession highs and the return of increasingly aggressive deal structures, investors are seemingly willing to trade covenant protection for higher yields. While the demand for yield and accommodative monetary policy provide strong, technical undercurrents, generating above-market returns will require an even greater emphasis on fundamental credit analysis to unearth undervalued opportunities. We believe bank loans, particularly upper middle-market financings, offer attractive relative value going forward. REPORT HIGHLIGHTS: • Rebounding from a 1.8 percent return in 2011, bank loans gained 9.4 percent in 2012. High yield bonds returned 14.7 percent in 2012, compared to 5.5 percent in 2011. • Nominally low yields throughout the fixed income universe drove capital into the leveraged credit sector, with issuers responding with record level supply. 2012 high yield bond issuance totaled $346 billion, the most ever, while the loan market enjoyed its highest level of issuance since 2007. • Since 1992, the Credit Suisse Leveraged Loan Index, on average, has yielded 130 basis points less than the Credit Suisse High Yield Index. With bond yields finishing the year at 6.25 percent, the lowest level on record, this differential has narrowed to 30 basis points, increasing the relative value of bank loans. • As default rates have stabilized below historical averages, investors have been willing to tolerate increased credit risk in exchange for incremental yield. During 2012, covenant-lite loans represented 33 percent of total bank loan issuance, three times the average of the previous four years.