Voor het eerst in de geschiedenis liggen highyield-bedrijfsobligaties op koers om voor het tweede jaar op rij een negatief totaalrendement te boeken. Is dit het dieptepunt voor high yield? Onze gasten zijn twee ervaren portefeuillemanagers: Sander Bus en Roeland Moraal.
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Erika van der Merwe (EM): 2022 has been a year of records for bond investors. In the first six months, the fixed income asset class clocked its worst performance since 1788. And, unusually, bonds have weakened at the same time that equity markets got hammered.
Welcome to a new episode of the Robeco podcast
In this episode, we take a look at one particular segment of the fixed income market, namely high yield corporate bonds. Here, too, new records have been set. Never before have there been two consecutive years of negative total returns in high yield. Investors are now wrestling with a question of whether this is the low point for high yield. Our guests are two veterans in the field, Sander Bus and Roeland Moraal, who are portfolio managers for global high yield at Robeco. Welcome. So good to have you on the show.
Sander Bus (SB): Thank you.
Roeland Moraal (RM): Thank you.
EM: So you've both been doing this for about 25 years. Now, to my mind that always is such a wonderful idea to be able to speak to someone with that kind of perspective, that wisdom and the insight. So tell us some of your stories, the milestones that you've lived through. For instance, where were you during the emerging market debt crisis or the dot-com crash or when the subprime market started unraveling?
SB: Yeah. Shall I kick off, Roeland? I started at Robeco and with high yield in 1998. So that was really at the infancy of the European high yield markets. I remember the first European deals coming to the market. That's why we launched a global product in the beginning because it was 99.9% dollars and a little bit of euros. And over time the euro part did grow. So when I started at Robeco, actually Roeland was already there, I started more or less on the day that Russia defaulted. So it was in that episode, the late nineties where one after the other emerging market crashed. Thailand, Mexico, Argentina, Russia. And in that part, I joined Robeco at the emerging debt part. But that didn't really have a future at that time. So when the European junk bond market started, then we launched a global high yield product. And over time, we did grow and experienced the dot-com crisis, the global financial crisis, and a whole bunch of other crises. But we survived all of them.
EM: Roeland, what really sticks out for you over this time period?
RM: It's funny, Sander says that I was around already, so I started my career here at Robeco, but not at the investment department. I was in a research department before that. And one of the things we did was we wrote about funds and strategies, both from Robeco, but also from outside investors. And actually, I wrote a paper about the high yield bond fund that had just started. But then as an analyst. And I know that we were looking for showcases to make it a bit lively and understandable for clients. And Samsonite, I think was one of the issuers at the time that we used as an example, but also Yellow Pages, also a famous part of the high yield market back then. So to give some understanding to clients and investors. And the dot-com crisis, actually I still was at the research side of things and I know that quite well because my eldest daughter was born in that time and I was out for a number of weeks to be home and I came back and the market had changed quite a bit with quite a crash in that period. So that's, that's still somewhere in my memory. So yeah, that and also I think dot-com crisis I just mentioned, for example, Yellow Pages. We are so old that we are still from the time of phone booths and also phone books and the Yellow Page books.
EM: From that point, aside from phone booths, well, hardly being around and the Yellow Pages now a matter of history. What would you say is the one big thing for both of you that's changed in those 25 years in terms of how markets function or how you go about investing, What stands out for you?
SB: So I remember in the beginning we did everything ourselves. So as a portfolio manager, you also were the trader, you were the analyst, you were the salesman, you were investment specialist. So and now all these functions are separated, so it's much more in-depth. So the knowledge has gone up quite dramatically, with dedicated traders, dedicated analysts that really can dig deep into a story.
EM: Right. So perhaps, Roeland, suggesting how competitive the market has become. You really have to be focused and go deep in order to gain those returns.
RM: Yeah, I think it makes a ton of sense to have experienced analysts that have all the time in the world to dig deep in credit stories and to make sure that you have a full view of what's happening in corporates; makes a ton of sense to have us sitting behind the screens and watching markets instead of being out and talking to whoever is out there. So I think it's a total necessity. By the way, it's also interesting to mention that some issues haven't changed much. The high yield market is still pretty illiquid. It is still sort of an over-the-counter type market where trading over the phone is still something or over the chat is pretty usual, actually. So it remains a bit of an odd niche in capital markets, I would say.
EM: So the markets are pretty illiquid then. What's your best strategy to trade and to make sure that you preserving performance?
RM: I think it's indeed very important to keep in mind that especially in high yield, because it's an illiquid market, that trading costs are an important factor to take into account. So if you trade a lot in and out for your portfolio, that increasingly pressures your performance, and I have sometimes the impression that say in the competition, younger people tend to think that you can only make performance by doing things. So by buying and selling, and selling again and buying again. And from our experience, in our view, it's actually something that you have to try and suppress that -
EM: …that urge.
SB: Not be too overconfident.
RM: Not be too overconfident. Do your homework, stick to your views, stick to your positions, and try to reduce trading, because trading is cost, and cost means less performance. And that holds way more so for high yield than, for example, large-cap equities, where you can trade at very minimal costs. And that's not the case for high yield.
SB: That's also why I think the primary market is very important to us because that's actually a moment where you can buy into a new issue in size without costs. That's why we have very strong contracts with syndication desks and we are sometimes even the driver of a new transaction for a company.
EM: You've spoken about being that focused on markets. And I'm sure that this year and in fact, since about March 2020, how very much you were probably almost chained, glued to your desks with all the volatility. So looking only at this year that's been so changeable, what's driving these moves? Is it primarily concerns about inflation or are there other factors at play?
SB: Yeah, I think what is happening, we have two crises in a row. We had Covid, then we came out of Covid and immediately we got the geopolitical crisis in Russia. And we had central banks responding to inflation, and fiscal authorities responding. That is a big change. And what really changed now is that initially with quantitative easing, you had rates going down and risk going up. So everything moved in the same direction. And now with the removal of quant easing, you see the opposite. So everything goes down, rates go up, equities go down, spreads go up. So the correlations become almost one. So that is quite exceptional because usually we have negative correlations. When spreads go up, rates go down and vice versa, which is the beauty of high yield that you have these two elements combined. And it's a buffer that gives you very stable returns. And that is different now; that negative correlation will come back, probably when this rate cycle is over and markets are more in a recession, then rates will eventually come down and spreads maybe can stay high. But then you have these opposing forces that give you nice returns for high yield.
EM: So, Roeland, in short, strange, unusual developments. But if we're still trying to get the driving force; are the driving forces different from what you see in fixed income more generally, so sovereigns, for instance, concerns about inflation or concerns about underlying fundamentals?
RM: Yeah, markets are always driven by views on fundamentals, but also by technicals, demand, supply, the need to make a certain return. And if you think about the last many years, actually, basically since the great financial crisis, we are in an ever-lower rates environment. And if you think of yourself as a pension fund that needs to make a 4% return on assets, with rates in Europe being zero or negative, people have been driven into riskier assets. Had to find the niches in the corners of capital markets to find some yield and some return. And I think this year is a year where that is changing very dramatically and very rapidly with Treasury yields above 4% now, but also in Europe, clearly above 2% for general govis, I think France, Spain even more so. Basically you can earn a return without risk. And that means that for risky assets, something else has to make it attractive.
RM: I think that's also what is driving down the returns on risky assets; that you have an alternative again, as a very broad investor.
EM: And in that, are you including high yield as risky within fixed income? So in that, could you just sketch the picture where high yield fits into the asset allocation picture?
RM: It's generally speaking, I think, viewed as a more of a niche with both debt characteristics and equity characteristics. And Sander alluded to, with pretty low volatility, because of the beauty of this whole effect, that when rates go down, that has an upward price effect on our yields that is beneficial for the price of your high yield bonds. But usually rates go down in a risk-off environment and that is when spreads go up a bit.
EM: By “spreads”, you mean?
RM: So the credit spreads. That is the compensation you receive for owning -- for basically lending to a less creditworthy issuer.
EM: Relative to the risk-free rate?
RM: Relative to the risk-free rates, yeah. So if you lend to the German government, you earn two, two-and-a-half percent these days, that's risk free. It's considered risk free. If you do so to Volkswagen, you receive a small premium because Volkswagen can always default, but the risk is low. That's a single A-rated company. If you invest in some small ceramic hip and knee manufacturer in Germany with [EUR] 400 million in revenues, then you get a higher compensation for lending to them because that's a company that can easily default on whatever is spiking, energy prices, for example. So that's how it works.
EM: Sander in common parlance, high yield bonds are often referred to as ‘junk bonds’, which sounds awful. So is it junky? Is it worthless? Is it overly risky?
SB: It's not worthless. Definitely not. Now, the phrase ‘junk bonds’, in fact, it's a negative name for high yield. If you focus on the risk, then yeah, there is a higher risk of default. That's [what] you get paid for. So people that focus on the good side, the higher returns, say it's a high yield bond. People that focus on the negative side say it's a junk bond, but it's the same thing.
SB: And as investors, we always are aware of the risks. We screen all our companies for downside risk and our strategy is to win by not losing. Try to skip the junk bonds and be left with the high yield bonds.
EM: And this is classic credit investor talk, right? Always focusing on what you could lose and avoiding that at all costs.
SB: Yeah, absolutely. Because yeah, the equity holders have the upside, but our upside is always kept to par, basically, because that's what you get back in the end. And the coupons, of course, in the meantime. So we can lose a lot, but we cannot win on individual names. The beauty is that if you build a diversified portfolio, then you can diversify the risks away and you get a very nice total return. Actually, I just checked this morning, since the beginning of this century, the MSCI Global Equity Index in dollars had a lower return than the global high yield index in dollars. So high yield gives you an equity-like return over decades with a lower risk.
EM: So if you were to put that – if you were to create, set out, a continuum of assets; so sovereign bonds would be the least risky, followed by corporate bonds, followed by high yield, and then you have equity thereafter?
SB: Yeah, I would say so.
EM: So where are you seeing the opportunities right now? And before we go there. Here are two commentators. The first is referring to US high yield, the second to European high yield. And let's have a listen.
Recording 1: We’re only one-third of the way through the pricing of high yield, high yield in recessions, credit spreads don't peak until the middle of the recession, and they peak at around 800 to a 1000 basis points all the time. There's at least another 300 basis points of widening yet to go.
Recording 2: If you look at the yield, what we discussed and also the spread widening that we have seen, we are really getting close to or even at the level that a lot of negative news is priced in. So with a spread of approximately 600 basis points versus what you can expect, maybe 800 basis points, if you get an extremely weak economy and a lot of pain, etc. in financial markets. Yeah, I think that we are there or almost there.
EM: That was Bob Michele, Global Head of fixed income at JPMorgan Asset Management, talking to Bloomberg. The second voice was Sjors Haverkamp, portfolio manager for high yield at NN IP on the NN IP podcast. I see you recognize some of those voices, both of you smiling. So just some reaction to that news. So my understanding, as someone not especially knowledgeable on the market, is that both of them are saying, we're getting there, but the market still has some way to go before it's at its low point.
SB: Yeah, it's interesting. I think both of them are right, in a way. So the average high yield spreads can indeed be 800 basis points in a recession. But the thing is, it really depends on the quality of the market. And at the moment we have much more BB risk than CCC risk.
EM: So in other words, better-rated companies?
SB: Better-rated companies than historically. So the average quality of companies is better. So therefore, probably the peak in spreads will also be lower than in previous recessions. And at the same time, we don't invest in an average; we invest in individual companies and there can be great dispersion. What we've seen so far is more or less indiscriminate widening of spreads, especially in Europe, regardless of the quality of the individual company. Once you get into a recession, then further spread widening will happen in individual names that jump to default. And then you can have a few names in the benchmark that have maybe 20,000 basis points of spreads, that you never get because that company will default, but that can increase the average quite dramatically. So and then we say we cannot invest in the average, then you invest in BBs, which will be much lower than the average at that point and maybe even lower than today's price. Because today we see quite some value in the high-quality part of the market. So the BBs, high Bs.
EM: So that is where you see the opportunity, at the quality end of high yield, Roeland?
RM: Yeah. And I think the first speaker was talking US high yield, the second was talking European high yield. And where we also see more value is currently in European high yield. So if you just look at valuations, then you get much higher valuations, a higher spread, a better yield on European high yield than on US high yield, even if you correct for things like quality. So the European index is higher quality, but if you correct for it, then still, Europe is cheaper. But you could say it is for very good reasons. So we have the war in Ukraine at our doorstep. We are not energy self-sufficient like the US is, which is an energy exporter basically. So they are reaping certain benefits. We are suffering from certain situations more than the US does. But when you talk investing and taking positions, it is all about what's in the price already. So you have to have your own view, but you have to confront your own view with what the market is thinking. And if there is a discrepancy, then you can take a position and you can gain from it. So the market is currently very convinced that Europe is in a very stressful situation, that a recession is going to be unavoidable, that we're already in it. But it also means that Europe is priced for it. So the spreads, the risk premium in Europe is high because people say, well, the default cycle is upcoming. So if you buy today, you buy that perception of the market already. In the US, on the other hand, the US market seems to be very relaxed about the potential of a recession. So I would say the majority still thinks that a recession is likely avoidable for the US market, and you see that reflected in valuations. So that market is pretty expensive. We think that the US is not going to avoid a recession and if you think so, then you disagree with the market and then you have to take a position and that position is that you have to be underweight or short or not involved in the US markets.
EM: Is this an example of you, because you always say that you’re contrarian investors, is about you seeing things differently and being bold enough to take a stance?
RM: Yes, you always have to first look at what is the market thinking, what is the market paying attention to and what is it pricing in? And very interesting examples are, for example, if you look at the oil price and credits that are oil related. So the E&P sector in the US, for example, is a pretty large sector in US high yield; companies that pump up oil and sell it. If the oil price goes down, people start extrapolating the current oil price and say it goes from [USD] 60 to 25, as we saw in late 2015, and then the market somehow starts thinking, gosh, we're never going to get out of this situation, oil will be below USD 30 forever. And then these companies will be priced accordingly. So super cheap because no one wants to hold them. That's an overreaction because you know that at some point something will happen. No one knows. We don't know either. You don't have to know what is going to happen. You just have to look at what is the market thinking.
RM: Is that likely or is it is it an overreaction? So, for example, in late ’15, early ‘16, we made a lot of money by at some point investing heavily in commodities because everyone was puking them out, basically because everyone was extrapolating the then current situation of very low prices and then at some other point, oil starts rising again and then oil’s at 100. And everyone says, yeah, oil will remain at 100 forever; these companies will -- it's gold -- they're flush with cash. They'll earn tons of money. Yeah. That's when you see that reflected in the price again. And it will trade too expensive. So it's always about what is the market thinking, how is the market acting? And then try to take the opposite position on that.
EM: So, Sander, you've said, or Roeland’s said, Europe is where you’re looking in particular; are there particular sectors that you find attractive that the rest of the world is disregarding?
SB: Yeah, what is really interesting is that there are a lot of companies that are actually global companies. They have operations both in the US as well as in Europe, and they issue dollars and euros. So you can buy, you can choose what to buy. And what we see is that when European spreads widen, that also the spreads of these global companies, that you see the euro bonds widen, versus the dollar bonds, which is really strange because it's the same risk, the same credit box, the same rating, same seniority. So that's because markets are often segmented. And when there are outflows in European funds, asset managers have to sell indiscriminately, shave off entire positions. And then you see discrepancies between dollar and euro valuations, even for the same company. And that's where the opportunities are and those we can reap as a global investor.
EM: So to emphasize that point, the fact that you're a global investor, you're looking at Europe and the US. So how unusual is that? Is it typically segmented where you’re euro only, US only.
SB: Yeah, there are more people that call themselves global investors, but they often have portfolio managers in Europe only looking at European issuers and in the US only looking at US issuers. So they optimize two silos and then put them together, which is not truly global investing. And I think that's the difference with how we approach it.
EM: Let's push that a bit further. What about emerging market high yield or Asian high yield, for example? Is that incorporated in your universe?
SB: It's incorporated in our universe. So each of our analysts is, or, we organize our analysts by sector and within their sector they look at emerging markets and developed markets, US, Europe, Asia. We have funds that are not including emerging markets in their investment universe. For instance, the Global High Yield fund doesn't have it in the benchmark, but opportunistically, we can invest in emerging markets off benchmark. But for our SDG high yield funds, we do include emerging markets. So we can do both. But it's for every strategy, even if you don't invest in emerging markets, it's very valuable to have analysts that look at it because we can identify trends in emerging markets that are very relevant for developed markets and vice versa.
EM: Now, you've both spoken about the fact that you see opportunity in high yield, particularly in European high yield. What about the timing of that? Would you be buying now, increasing your exposure? Because there still are so many risks. I mean, how bold are you?
RM: We just learned that Sjors is doing so now, isn’t he? I think you have to be a bit humble and it is super hard to exactly and always time the peak or the trough. So we would like to wait exactly for the peak in spreads. So the low in prices basically, to go all in and then be exactly right. But you know that's hard if not impossible to do. But if you look at European high yield where it stands today, one observation is, I think pretty simple. If you buy high yield bonds today in Europe, you receive a certain yield. Well, even if some of these companies default, you make a yield on the other companies. So there is a buffer in it. And likewise, if spreads were to, credit spreads were to widen further, that means that prices go down – because the starting point is around 8% current yield on the portfolio. Even if spreads were to widen another, say, 200 basis points, you still end up next year with a flat or positive total return. So there is this buffer in the yields that you're getting at current levels, that makes it interesting. So for an investor to step into European high yield now, quite a bit has to happen to the portfolio or to the markets for this return over the next 12 months to become negative. I think that's the beauty of where we are today and then, say, for our strategies, we are very much an up-in-quality investor. So I think if you talk about our philosophy or investment philosophy, what would we think are important issues to take into account when investing? One important one is that there are always yield chasers. There are always people that think that buying into a higher yield also means a higher return. But yield is not return. Yield is a reflection of risk and very high yield companies tend to default from time to time and then you're left with nothing. So we did a lot of research and our thesis is that pays off to be up in quality. And if you have an up-in-quality portfolio, that also means that you will have less defaults. So I'm pretty comfortable with the current portfolio for the coming 12 years for it to –
EM: 12 months?
SB: But also for 12 years? (laughter).
EM: There you go (laugher). Very bold!
RM: We will hopefully be around for a bit, a little longer! But for the coming 12 months, I think you can pretty comfortably say that a positive return is, has a very, very high likelihood.
SB: Erika, maybe, on these defaults – it's good to remember that when default rates peak, those are the best years for high yield, which sounds counterintuitive, but if you look at the history, 2003 and 2009 were very high total-return years for high yield. That's exactly when default rates were at peak levels. And that's because markets are always one to two years ahead of things. So we are now the market is currently anticipating default rates that will happen next year and the year after. Once they really happen, they are fully priced in and at that point, the market can also distinguish between the survivors and the winners. And once we see what the survivors are, that's the moment when we start to rally.
EM: Final question, also looking to the future, also philosophically, from what you're seeing in markets right now, so much has changed fundamentally in the way policymakers function, where markets are pricing. You spoke about the breakdown of the negative correlation, for instance, between fixed income and equity. Do you think that this is a fundamental shift in things, that it's permanently different, or do you expect that there will be some reversion back to a median, a mean, whatever that might look like?
SB: Well, human behavior never changes, so there will always be periods of greed and fear and overshooting markets. So that is not going to change. Of course, politics do change from time to time. We have had 30 years of very nice periods for markets where China joined WTO or the Berlin Wall fell. So we had globalization, which was very beneficial for companies. That probably has peaked now. So we could see a more segmented globalization where certain strategic sectors will be more onshored or governments maybe take a bigger role than in the past 30 years. So that is going to change, but that creates opportunities as well. And we look at those opportunities. So for us, it's never boring. It's a new regime, maybe, but human behavior is the same. But there are still opportunities.
EM: Final words from you, Roeland?
RM: There’ll always be a high yield market because there will always be smaller and medium-sized companies that need financing and that want to not be just reliant on their relationship bank, but want to tap capital markets. And they will always come to market and find us happily able to help them out if their quality is good enough.
EM: Roeland and Sander, thanks so much for your insights. And I'm sure the good companies will know where to find you.
RM: Thank you.
SB: Thank you so much.
EM: And to listeners, thanks for being part of this conversation. If you've enjoyed the show, please rate the Robeco podcast on your platform. And we'd love to hear from you so please send us your comments, feedback and suggestions to firstname.lastname@example.org. You'll find all of our podcasts on your favorite podcast platform, of course, as well as at robeco.com.
Voice: Thanks for joining this Robeco podcast. Please tune in next time as well. Important information. This publication is intended for professional investors. The podcast was brought to you by Robeco and in the US by Robeco Institutional Asset Management US Inc, a Delaware corporation as well as an investment advisor registered with the U.S. Securities and Exchange Commission. Robeco Institutional Asset Management US is a wholly owned subsidiary of ORIX Corporation Europe N.V., a Dutch investment management firm located in Rotterdam, the Netherlands. Robeco Institutional Asset Management B.V. has a license as manager of UCITS and AIFS for the Netherlands Authority for the Financial Markets in Amsterdam.