Martin Horne

Director of Global Public fixed income Investment

The Baring Global High yield Investment team analyzes the latest developments in the high-yield and senior mortgage bond market and explores how factors such as rising interest rates and inflation affect the future trend of the market.

What impact will rising coupons on 10-year US Treasury bonds and rising inflation concerns have on the high-yield bond market?

Overall, the maturity of the high-yield bond market is relatively short, so its interest rate sensitivity is lower than that of some fixed-income asset classes. This can be confirmed by the fact that the correlation between high-yield bonds and US Treasury bonds was generally low or even negative in the past. At the same time, it should be pointed out that there are usually higher economic growth and inflation expectations during interest rate hikes. Such an inflationary environment tends to push up the high-yield bond market and may help narrow spreads and improve the performance of the asset class.

What has been the performance of issuers in the high-yield market since the novel coronavirus epidemic continued? Which industries have more investment value?

Since the sharp fall in the market in March 2020, financial markets and asset prices have recovered strongly, and the upward momentum has continued after good news on vaccine research and development at the end of last year. Although various industries are still hampered by city closures and supply chain disruptions, the successive introduction of supportive monetary policies by central banks and large-scale fiscal stimulus measures by governments have provided timely support to the global economy. High-yield market issuers have also been able to raise money to refinance short-term debt and improve liquidity, giving them breathing space during a period of short-term disruption caused by the novel coronavirus epidemic.

Throughout the current market, from a relative value point of view, because valuations are still attractive, we are optimistic about pro-cyclical tourism and leisure. We believe that fiscal stimulus measures in mature markets continue to support consumer consumption and that countries begin to restart their economies, creating upward potential for the sector.

In the current environment, are senior mortgage bonds more valuable than high-yield bonds?

The investment opportunities offered by the two markets are slightly different, and there are also significant differences in their related investable areas. For example, global senior mortgage bonds have a higher proportion of investment in the European market, while unsecured high-yield bonds tend to have a higher allocation in the US market. From an industry point of view, global senior mortgage bonds account for a higher proportion in industries such as tourism and leisure, while overall high-yield bonds account for a higher proportion in industries such as energy.

Global senior mortgage bonds also have a slightly lower maturity, meaning they are less sensitive to changes in interest rates. In addition, in terms of corporate capital structure, senior mortgage bonds rank first in terms of priority, followed by subordinated bonds and stocks. Senior mortgage bonds are also secured by some form of assets of the issuer, ranging from real estate to equipment to intangibles (such as software and trademarks). This means that in the event of a default, senior mortgage bondholders will be given priority over lower-level debt holders.

Looking ahead, what is the biggest risk facing the high-yield and senior mortgage bond market?

In terms of the epidemic, we need to pay close attention to the effectiveness of the vaccine, especially the variation and variation of new virus strains, as well as the deployment and management of vaccines around the world. While the US, the UK and parts of the Middle East have taken the lead in making significant progress on vaccination, progress in other regions remains slow and could affect the pace of economic restart.

Whether asset prices will continue to recover will also depend on whether global policymakers continue to introduce supportive measures. For example, if the central bank tightens monetary policy and withdraws money from financial markets prematurely, it may have an adverse impact on the market. Large fluctuations in long-term interest rates and inflation expectations will also increase volatility. But as mentioned above, high-yield bonds are generally less sensitive to interest rates. Therefore, we believe that as long as interest rate increases and inflation expectations are manageable and occur in good economic growth expectations, we will continue to create a favourable environment for high-yield bonds.

For the purpose of this paper, high-yield bonds are subordinated investment grade bonds with credit rating. Secondary investment grade refers to "BB+" or lower rated by rating agencies Standard & Poor's or Fitch, "Ba1" or lower by Moody's Corporation Investor Service, or equivalent rating by other internationally recognized rating agencies.