High yield: The forgotten asset class to watch
IN Partnership with
Brandywine’s John McClain on why high-yield bonds offer more stability and opportunity than you might think in today’s volatile market
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FOR MANY investors, high yield isn’t exactly the first asset class that comes to mind. It lacks the shine and perceived excitement of private credit, and unlike other investment opportunities, it hasn’t experienced much growth in the past decade. Yet, according to John McClain, portfolio manager at Brandywine Global, a specialist investment manager of Franklin Templeton, that’s precisely why it deserves a second look. “Value is found where others aren’t looking,” McClain says, and high yield is filled with potential that most investors are simply overlooking.
Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers specialization on a global scale, bringing extensive capabilities in fixed income, equity, alternatives, and multi-asset solutions. With more than 1,300 investment professionals and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and approximately US$1.6 trillion (approximately CAN$2.2 trillion) in assets under management as of January 31, 2024.
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US corporate high-yield bonds: Performance during recessions
“We saw it in 2022, and we saw it again in 2023. When yields reach the 9% to 10% range and credit spreads hit 500 to 600 basis points, investors start paying attention”
John McClain, CFA,
Portfolio Manager,
Brandywine Global
At its core, a high-yield bond operates very differently from equities. While stocks may fluctuate unpredictably, driven by market sentiment and external factors, high-yield bonds come with two key features: a contractual coupon and a final maturity date. This creates an inherent predictability that equities often lack. The bond’s price can trade at a discount to their face value, particularly during periods of market volatility, but this discount tends to shrink – or “collapse” – over time as the bond approaches maturity and the issuer repays the full value.
For McClain and his team based in Columbus, Ohio, the
strategy is clear: hold the bond, collect the coupon, and let the discount close as maturity nears, generating consistent returns. This predictability makes high yield an appealing choice for investors who prefer a clear-cut path to returns, especially in today’s uncertain market where others may be chasing riskier, trendier assets.
From an asset allocation perspective, McClain sees high yield as the ideal middle ground between core fixed income and equities. It’s not just about improving returns but also about managing volatility. “High yield typically enhances returns and dampens volatility when incorporated into broader portfolios,” McClain explains. And as the investment landscape shifts, clients are increasingly turning away from core fixed income and moving into lower-quality, lower-duration credit portfolios. The reason? The responsiveness of high yield to rate cuts, and its ability to capitalize on the front end of the Treasury curve, specifically in the zero- to five-year range. In today’s market, that’s a major advantage.
High yield’s most compelling feature might just be its track record of stability. Investors often think of junk bonds as risky, but McClain points to the historical resilience of BB-rated bonds, which make up more than half of the high-yield market. “The last time the BB-rated part of the market defaulted at more than 1% was in 2002,” McClain says. This level of consistency is particularly important in an environment where many investors are looking for ways to reduce risk without sacrificing returns.
So why does high yield get a bad rap? The answer, McClain suggests, is perception. It’s not a flashy asset class, and it’s been out of the spotlight for years. But for those who are willing to look beyond the surface, high yield offers a unique blend of income, stability, and opportunity that’s hard to find elsewhere.
When it comes to regional opportunities, McClain and his team see more promise in the US high-yield market compared to Europe. In 2024, the US economy has decoupled from the rest of the world, and US high yield has been buoyed by stronger fundamentals and technicals. “We certainly have a preference for US over European high yield at the moment,” McClain says, adding that the demand in the US market is being driven by limited net issuance and investor appetite that remains insatiable.
One of the largest sectors in the US high-yield market is energy, which has benefited from the growing demand for US natural gas. Companies in this sector have stronger balance sheets and more robust business models than they did during previous downturns in 2015 and 2018. Financials are another sector that has seen a resurgence in high-yield opportunities, particularly as regional banks have pulled back from lending in the wake of the Silicon Valley Bank crisis.
In today’s market, high yield is very different from what it was in 2007. Dislocation funds are active, and strategies focused on distressed credit are already in place to scoop up opportunities.
A key structural shift that sets today’s market apart is the role of the Federal Reserve. During the COVID-19 pandemic, the Fed stepped in to buy high-yield bonds, notably backstopping companies like General Electric. This intervention by the Fed is critical, McClain argues, because it highlights the difference between high yield and other forms of credit risk. “The Fed can buy credit. It can’t and won’t buy an office property, collateralized loan obligations [CLO], or provide a loan to a private company,” he says. This distinction gives high yield an added layer of security, one that many investors may not fully appreciate.
McClain also points out that there is now a clearer gauge for where the floor is in the high-yield market. “We saw it in 2022, and we saw it again in 2023,” he says. “When yields reach the 9% to 10% range and credit spreads hit 500 to 600 basis points, investors start paying attention. And it’s not just the traditional credit investors – sovereign wealth funds, private credit, and dislocation funds also begin moving into the market.” So, while many investors might be waiting for the perfect opportunity to buy, McClain suggests that these moments of spread blowout are increasingly difficult to evaluate and capitalize on.
Global sets itself apart from its competitors through a high-conviction strategy, the Franklin Brandywine US High Yield strategy. McClain’s team typically holds 150 to 200 positions, far fewer than the industry norm, allowing them to be more selective and focused. “We align ourselves with our clients,” McClain says. “The majority of our liquid net worth is tied into the strategies we manage. We eat our own cooking.”
For those waiting for spreads to blow out before buying into high yield, McClain offers a word of caution. “While many investors wait for the ‘fat pitch’ – the perfect buying opportunity – today’s market isn’t like 2007,” he warns. With the Federal Reserve’s involvement in high yield during the COVID-19 crisis, McClain believes the floor of the market is better understood, and waiting for a major dislocation may cause investors to miss out on the opportunities currently available.
As McClain puts it, “High yield is a niche asset class, but it’s one that we’ve been living and breathing for more than a decade.” And for investors looking to enhance returns while managing risk, high yield offers a compelling opportunity. In today’s rapidly changing market, where the race to find yield and stability is more competitive than ever, high yield deserves a place at the table. With strong fundamentals, attractive income, and limited risk, this “forgotten” asset class may just be ready for its time in the spotlight.
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The understated power of high yield
US vs. European high yield: Where’s the opportunity?
Published November 4, 2024
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“High yield typically enhances returns and dampens volatility when incorporated into broader portfolios”
John McClain, CFA,
Portfolio Manager,
Brandywine Global
12/31/2007-
6/30/2009
3/31/2001-
11/30/2001
7/31/1990-
3/31/1991
Average
2/29/2020-
4/30/2020
-40%
-30%
-20%
-10%
0%
10%
Bloomberg US Corporate High Yield Index
S&P 500 TR USD
2003
0%
Global Corporate annual default rates by rating categorY BB
2004
2005
2006
2007
2008
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
0.1%
0.2%
0.3%
0.4%
0.5%
0.6%
0.7%
0.8%
0.9%
1%
1
One of the most common objections McClain hears is that spreads in the high-yield market are too tight. But in his view, tight spreads are not necessarily a bad thing. “Spreads are tight for a reason,” he says, “because we don’t see a material pickup in defaults, and we have very high-quality businesses.” Additionally, the dollar price of the index is trading below par, which creates even more opportunities for investors to win.
Another major concern is the fear of an impending recession. Investors often hesitate to allocate to high yield in uncertain economic times, but McClain offers a compelling counterpoint: “Have you de-risked your equity bucket first?” High yield consistently outperforms equities going into and coming out of recessions, with a notable exception of the COVID-19 anomaly. And companies in the high-yield market have been preparing for economic turbulence for the past two years.
Addressing investor concerns
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As for the argument that today’s junk bond market carries excessive risk, McClain is quick to dismiss this as an outdated view. “Much of the excess risk is in private credit today,” he explains. The high-yield market has evolved significantly since the days of Michael Milken in the 1980s. Today, the companies issuing high-yield bonds are much larger, more established, and often household names. The team often explain that the high-yield market is not like your parents’ or grandparents’ version of high yield.
When it comes to managing high-yield portfolios, Brandywine
Important Legal Information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market.
Commissions, trailing commissions, management fees, brokerage fees, and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.
Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.
Source: Default, Transition, and Recovery: 2023 Annual Global Corporate Default and Rating Transition Study by S&P Global, March 28, 2024
Source: Bloomberg; recession periods since 1990: 7/31/1990–3/31/1991, 3/31/2001–11/30/2001, 12/31/2007–6/30/2009, 2/29/2020–4/30/2020; considering last month of expansion vs. last month of recession, and last month of recession plus the following months
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