The Case for High Yield, Revisited

Transcription

1 The Case for High Yield, Revisited DAN DOYLE, CFA MANAGING DIRECTOR AUGUST 214 While volatility has recently increased in the high-yield market, we believe this has been largely driven by technicals, not a downturn in the underlying fundamentals that typically drive performance in the asset class. On the following pages, we discuss the current fundamentals in the high-yield market, its performance in different economic environments and the differentiating characteristics of Neuberger Berman High Yield Bond Fund. RATE AND POLITICAL WORRIES ASIDE, CONDITIONS ARE SUPPORTIVE After 1 consecutive months of posting positive returns, the high-yield market experienced a setback in July 214. Triggering this weakness, in our view, were technical factors not a reversal in underlying fundamentals. More specifically, geopolitical issues in Ukraine, Gaza and Portugal, coupled with the Argentine bond default, negatively impacted investor sentiment. Adding fuel to the fire was robust second-quarter GDP growth that led to expectations that the U.S. Federal Reserve would tighten monetary policy sooner than previously expected. While geopolitical issues are likely to continue, we believe the highyield market experienced nothing more than a short-term correction and some profittaking and we wouldn t be surprised to see a fairly quick rebound. Generally speaking, high yield performance is driven by fundamentals, such as defaults, as well as the direction of the overall economy. Against this backdrop, we believe that the high-yield market remains healthy. Strong Corporate Fundamentals 72 While 85 1 volatility 3 has 67increased, 1 48 we feel 1there 1are 55 many 55 reasons 1to 1 remain 83optimistic 31 72about 9 1 high yield. First, corporate fundamentals continue to be supportive, in our view, given generally healthy balance sheets, ample liquidity and cash flows that allow most issuers to handily meet their debt obligations. Against this backdrop, leverage in the overall U.S. high-yield market remains modest at 4.1x (debt/ebitda) versus 5.2x in 29. C 6 M 3 K 3 FIGURE 1: LEVERAGE REMAINS MODEST Total Debt/EBITDA Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q Sources: J.P. Morgan; Capital IQ. Note: Includes debt-weighted metrics for 446 HY companies; excludes Financials and Utilities. 1

2 New Issuance Is Focused on Refinancing Many corporations have proactively capitalized on the current low interest rate environment to reduce their borrowing costs and extend their maturities. This is evident when looking at the charts below. In 27, more than half of new issuance was used to fund aggressive actions, such as mergers and acquisitions and leveraged buyouts. Conversely, through the first half of 214, 6% of new issuance has been used for refinancing. FIGURE 2: VOLUME BY PURPOSE As of 12/31/7 As of 6/3/14 2% 3% 21% 35% 51% 6% 16% 12% M&A/LBO General Corporate Refinancing Dividend Source: J.P. Morgan Global U.S. Dollar-denominated High Yield Market Size, as of June 3, 214. Few Bonds Maturing Limiting Default Risk Given the large amount of refinancing, a relatively small amount of high-yield debt will be maturing in 214 and 215, minimizing pressure on borrowers. The high-yield default rate has been and we believe will continue to be well below its historical average of 4% over the last 25 years. FIGURE 3: LIMITED MATURITY SCHEDULE AHEAD Maturing U.S. Securities by Year ($bn) or later Source: Credit Suisse 214 Outlook for Western European High Yield and Leveraged Loans, December 5, 213. Note: For each year set forth above, the table shows the amount of leveraged loans as of November 29, 213 expected to mature. 2

3 FIGURE 4: DEFAULT RATE REMAINS LOW Par-weighted default rate (%) 12.% 1.% 8.% 6.% 4.% 2.% LTM Default rate High Yield Spread to Worst LTM E 215E Spread (bps) 2,6 2,4 2,2 2, 1,8 1,6 1,4 1,2 1, Source: J.P. Morgan Default Monitor. The default forecasts exclude TXU: Texas Competitive Electric Holdings Co. from the universe of Issuers. Defaults based on par amounts. Last twelve months (LTM) default rates including TXU are: HY 2.1%; Loans 4.1%. High Yield Spread to Worst is represented by the J.P. Morgan Global High Yield Index. Leveraged Loan Spread is represented by the Discount Margin (3-year life) of the S&P/LSTA Leveraged Loan Index. Valuations Have Become More Attractive An upside of the recent increase in market volatility has been more attractive valuations in the overall high-yield market. While certainly not as attractive as during the credit crisis, the spread to worst for the BofA Merrill Lynch U.S. High Yield Master II Constrained Index, which was 418 basis points (bps) over U.S. Treasuries at the end of 213 and had narrowed to 372 bps as of June 3, 214, has widened to 434 bps as of August 5 near the index s long-term average. FIGURE 5: AMID LONG DECLINE, SPREADS HAVE WIDENED MODESTLY BofAML U.S. HY 2% Constrained 2,3 1,725 1, Jul-7 Jul-8 Jul-9 Jul-1 Jul-11 Jul-12 Jul-13 Jul-14 Source: Bank of America Merrill Lynch, as at July

4 Fed Policy Shift Should Be Gradual The economy s weather-induced weakness from the first quarter of 214 is already in the rearview mirror, with current estimates for second quarter GDP growth of 4.%. For the year as a whole, we feel the U.S. economy will expand between 2 3%. With the Federal Reserve paring its asset purchases, interest rates could move somewhat higher, which would be a headwind for fixed income generally. That being said, the Fed has chosen to taper due to an improving economic environment, which we believe will be beneficial for the overall high-yield market. With the yield on the 1-year U.S. Treasury now trading around what we consider to be fair value, we do not expect rates to spike significantly higher and crimp refinancing activity. Despite Volatility, Potential for Spread Tightening While the fundamentals in the high-yield market remain strong, geopolitical worries could remain elevated. And as we have seen, the high-yield market, like all asset classes, is susceptible to non-fundamental driven volatility. In addition, lower dealer inventories of high-yield bonds have removed a buffer, which had historically dampened fund-driven movements in the market. Still, in our view, we believe that when investors again focus on the underlying fundamentals and the economy, the high-yield market should regain its footing, with the potential for some spread tightening as the year progresses. HIGH YIELD S BENEFITS TO DIVERSIFIED PORTFOLIOS Beyond what we consider generally constructive fundamental conditions for high-yield bonds, we believe that the asset class has a number of compelling characteristics for longterm investors with diversified portfolios. Equity-like returns with lower volatility: While past performance is no guarantee of future results, over time, the high-yield market has significantly outperformed other fixed income asset classes and compensated investors for the incremental risk they incurred. In addition, over the last 1 years, high-yield bonds have outperformed equities, with less risk. FIGURE 6: HIGH YIELD OFFERS FAVORABLE RISK/RETURN 1% Annualized Return 8% 6% 4% 2% U.S. Treasury U.S. Investment Grade Corporates U.S. Aggregate Bank Loans High Yield U.S. Equities U.K. Equities % % 2% 4% 6% 8% 1% 12% 14% 16% 18% 2% Annualized Volatility Sources: FactSet, Barclays POINT. All data for the 1-year period ended December 31, 213. Benchmarks used were Barclays U.S. Aggregate Index, Barclays U.S. Interim Treasury, Barclays U.S. Aggregate Credit Corporate Investment Grade Index, S&P Leveraged Loan Index, Merrill Lynch U.S. High Yield 2% Constrained Index, FTSE 1 USD Total Return and S&P 5 Total Return Index. 4

5 Yield advantage: The sector has also consistently offered incremental yields versus other fixed income asset classes, as well as the U.S. equity market. FIGURE 7: ASSET CLASS YIELD COMPARISON 8% Yield to Maturity Yield to Worst Dividend Yield 6% 4.7% 5.% 4% 2.8% 3.2% 2% 1.4% 1.4% 1.4% 2.% % U.S. Bank Loans U.S. High Yield Global Treasuries U.S. Treasuries U.S. IG Credit European IG Credit European Equities U.S. Equities Sources: Bloomberg, Barclays POINT. Benchmarks used were the S&P/LSTA Leveraged Loan Index, Barclays U.S. High Yield 2% Issuer Cap Index, Barclays Global Treasury Index, Barclays U.S. Treasury Index, Barclays U.S. Credit Index, Barclays European Credit Index, Euro STOXX Index and S&P 5 Index, as of June 3, 214. Resilient performance amid higher rates: Although investors have recently showed concern that high yield bonds could be negatively impacted when interest rates move higher, this has not been historically the case. High yield spreads have often tightened when five-year Treasury rates have increased. As a result, as shown below, the asset class has frequently delivered impressive returns both during those rate increases and in the periods that followed returning an average of 3.44% over the subsequent three months. FIGURE 8: HIGH YIELD PERFORMANCE IN RISING RATE ENVIRONMENTS 3-months Ending: Increase in 5-year Treasury Yields High Yield Bond Spreads Beg Month Spread Tightening/ (bps) Widening (bps) High Yield Bond Return High Yield Bond Returns Next 3 Months S&P 5 Return May % % 4.1% 2.9% May % % 1.% -1.2% Mar-9.81% % 5.7% -3.% Mar-92 1.% % 2.5% -2.6% Apr % % 1.1% -5.7% Nov-94.98% % 5.5% -3.8% Apr % % 1.9% 3.5% Feb-99.74% % 2.2% 6.8% Jan-.74% % -1.4% 2.6% Jan-2.9% % 3.% 7.% Aug % % 6.2% 5.1% Jun-4.99% % 4.4% 1.7% May-8.95% % -3.4% 5.8% Jun-9.9% % 15.1% 15.9% Dec-1.74% % 4.2% 1.8% Jul-13.7% % 3.% 6.1% Average.99% % 3.44% 3.24% Median.97% % 3.% 3.2% Sources: J.P. Morgan; S&P/ LCD. The table presented above represents performance when 5-Year Treasury Yields rose 7 basis points (or more) during a 3-month period. High Yield Bond Return is represented by J.P. Morgan Domestic High Yield Index. High Yield Bond Returns Next 3 Months represent the 3-month return of the J.P. Morgan High Yield Index for the 3-month period following the 3-months ending period, as listed in the first column of the table above. High Grade Bond Return prior to 1999 represents Merrill Lynch Corporate Master Index, after 1999 High Grade Bond Return is represented by J.P. Morgan High-Grade Index (JULI). Leveraged Loan Return prior to 27 represents S&P Performing Loans, after 27 Leveraged Loans are represented by the J.P. Morgan Leveraged Loan Index. See definitions of indices at the back of this presentation. Past performance is not necessarily indicative of future results. As with any investment, there is the possibility of profit as well as the risk of loss. 5

6 Given these characteristics, a key question becomes what investment strategy to choose to most effectively capitalize on high yield while limiting exposure to risk. We believe the Neuberger Berman High Yield Bond Fund has a number of attractive characteristics worth considering. NEUBERGER BERMAN HIGH YIELD BOND FUND: RISK-MINDED ACCESS TO ATTRACTIVE ASSET CLASS Neuberger Berman High Yield Bond Fund provides an appealing, risk-conscious way to access the high yield marketplace. The Fund s experienced management team seeks to add value through avoiding deteriorating credits, proactive industry and quality rotation and thorough relative value analysis. The Fund leverages the full high-yield credit quality spectrum to identify attractive investment opportunities. FIGURE 9: OUR APPROACH TO POTENTIAL RISKS Common Risk Considerations in the High-Yield Market GDP Defaults Fund Flows/Liquidity Interest Rates/Duration How We Approach These Risks We adjust the credit ratings profile of the portfolio between CCC and BBB rated bonds in response to the economic market environment. In particular, we tend to position the portfolio very conservatively ahead of a default cycle and very aggressively as the market begins to recover. We seek to avoid defaults through our large research team. We employ a very proactive, relative value approach to investing. We look to take advantage of flow-driven dislocations in the marketplace with relative value decisions based on our extensive fundamental research. We maintain duration typically within ½ year +/ the benchmark s duration. Spreads We reduce portfolio and individual credit risks as spreads tighten below 4. Given this strategy, we would expect the Fund to outperform its benchmark (the BofA Merrill Lynch U.S. High Yield Master II Constrained Index) during periods of elevated defaults (downside protection). We would expect to keep up with rising markets during economic expansions (upside participation). 6

7 Downside Risk Mitigation with Upside Potential The Fund s focus is on B- and BB-rated credits. The managers also seek to add value at important turning points in the cycle through opportunistic use of BBB- and CCC-rated bonds, as well as floating rate corporate loans. FIGURE 1: CREDIT QUALITY 1% 8% 6% 4% 2% % YTD 214 BBB and above BB B CCC RETURNS (%) YTD 214 U.S. High Yield Composite (Gross of Fees) Benchmark Value Added Source: Neuberger Berman Fixed Income as of June 3, The U.S. High Yield Composite performance above is of the Full Market High Yield Composite. The benchmark is the BofA Merrill Lynch High Yield Master II Constrained Index, which is designed to measure the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market, including 144a issues. The benchmark is calculated on a total return basis. Periods less than one year are not annualized. The performance presented is supplemental to the GIPS-compliant disclosure statement included as part of this White Paper in the back. Please see additional notes and disclosures, which are required as part of this paper. Preliminary returns, based on unreconciled data. Strong Record of Performance We believe the Fund s short- and long-term performance history clearly reflects its riskconscious bias and strong process. The Fund has often added value particularly in high default environments. FIGURE 11: NEUBERGER BERMAN HIGH YIELD BOND FUND (USD I ACC) 12% 1% 8% Benchmark Fund 6% 4% 2% % -2% -4% May-6 Jul-7 Sep-8 Nov-9 Jan-11 Mar-12 May-13 Jul-14 Source: Neuberger Berman, as of July 31,

8 Current Positioning We believe there is currently more interest rate risk than credit risk in the market. As a result, we have positioned the portfolio a half-year short duration relative to the benchmark (primarily with a 6.7% position in secured bank loans and a 5.2% underweight to BB and above rated credits). While the Fund is 2.2% overweight CCC-rated debt, we tend to avoid the distressed part of the CCC market. This means that the yield-to-worst of our CCC-rated position is below 6% versus an 8.25% average yield-to-worst in the CCC-rated portion of the index. FIGURE 12: BOND SUMMARY Fund Benchmark Weighted Average YTW (%) Weighted Average Duration (yrs.) Weighted. Average Maturity (yrs.) Bank Loan Weight (%) Number of Issuers 145 1,75 Source: Neuberger Berman, as of July 31, 214. FIGURE 13: CREDIT QUALITY PERCENTAGE Fund Benchmark BBB and above BB B CCC or lower Cash Equivalents Not Rated.. Source: Neuberger Berman, as of July 31, 214. As outlined above, we believe that fundamentals and valuations in the high-yield market remain healthy. In addition, this benign backdrop has been supported by the unprecedented global liquidity provided by the central banks in the U.S., Europe and Asia. For these reasons, we think we are just past the middle point of an extended credit cycle which could last 8 9 years versus the typical cycle of 3 5 years. While we re hard-pressed to see a scenario where defaults significantly increase over the next months, it s important to note that the Neuberger Berman team has a 17-year track record of high-yield bond management with only one default, over a period of 8 defaults in the marketplace. Even though we don t expect defaults to rise near term, we believe our large, experienced high-yield team is well positioned in seeking to achieve superior returns as the market evolves. 8

9 Investment Performance Disclosure Statement: Full Market High Yield Composite (Inception 12/1/1997) Composite Benchmark Returns Composite Period Total Return 1 (Gross of Fees) Total Return 1 (Net of Fees) Merrill Lynch U.S. High Yield Master II Constrained Index # of Portfolios Market Value (MM) % of Firm Assets Internal Dispersion % Total Firm Assets (bn) Composite 3-Year Standard Deviation Benchmark 3-Year Standard Deviation YTD June % 4.97% 5.64% 24 $7,52.7 N/A.6 N/A 7.27% 6.32% % 7.72% 7.41% 24 $7, %.1 $ % 6.43% % 15.61% 15.55% 21 $6, %.14 $ % 7.2% % 4.11% 4.37% 21 $6, %.32 $ % 1.96% % 15.18% 15.7% 12 $4, %.37 $ % 52.64% 58.1% 11 $3, % 2.54 $ % % % 11 $2, %.73 $ % 2.16% 2.53% 12 $2, %.18 $ % 1.13% 1.76% 1 $2, %.25 $ % 4.82% 2.78% 8 $1, %.13 $ % 8.74% 1.87% 12 $1, %.22 $ % 27.72% 27.97% 1 $1, % 1.26 $ % 3.75% -.53% 6 $ %.16 $27.4 Fee Schedule: First $5 million.55%; next $25 million.45%; balance.35%. (Subject to a minimum separate account size of $1 million.) 1 Past performance is not necessarily indicative of future results. As with any investment, there is the possibility of profit as well as the risk of loss. COMPLIANCE STATEMENT Neuberger Berman Group LLC ( NB, Neuberger Berman, the Firm ) claims compliance with the Global Investment Performance Standards (GIPS ) and has prepared and presented this report in compliance with the GIPS standards. Neuberger Berman was independently verified for the period January 1, 211 to December 31, 213. Prior to December 31, 211, there were two firm definitions, Neuberger Berman LLC ( NBLLC ) and Neuberger Berman Fixed Income ( NBFI ), which were independently verified for the periods January 1, 1997 to December 31, 21 and January 1, 1996 to December 31, 21, respectively. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The NB Full Market High Yield composite has been examined for the periods January 1, 1998 to December 31, 213. The verification and performance examination reports are available upon request. DEFINITION OF THE FIRM The firm is currently defined for GIPS purposes as Neuberger Berman Group LLC, ( NB, Neuberger Berman, the Firm ), and includes the following subsidiaries: Neuberger Berman LLC, Neuberger Berman Management LLC, Neuberger Berman Fixed Income LLC, Neuberger Berman Europe Ltd., Neuberger Berman Asia Ltd., Neuberger Berman East Asia Ltd., Neuberger Berman Singapore Pte. Ltd., Neuberger Berman Taiwan Ltd, Neuberger Berman Australia Pty. Ltd., Neuberger Berman Trust Company N.A., Neuberger Berman Trust Company of Delaware N.A., NB Alternatives Advisers LLC and NB Alternative Investment Management LLC. Prior to December 31, 211, there were two firm definitions for GIPS purposes: Neuberger Berman LLC and Neuberger Berman Fixed Income. POLICIES Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request. COMPOSITE DESCRIPTION The Full Market High Yield strategy is designed for investors who seek to achieve returns relative to a broad high-yield bond index. The emphasis is on avoidance of credit deterioration, sector rotation and relative value bond selection. The Full Market High Yield composite ( Composite ) represents the performance of all fee-paying, discretionary accounts, managed according to the Full Market High Yield strategy. The Composite was initiated and created in December A complete list and description of the NB composites and performance results is available upon request. BENCHMARK DESCRIPTION The benchmark is the Merrill Lynch High Yield Master II Constrained Index, which is designed to measure the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market, including 144a issues. The benchmark is calculated on a total return basis. Additional disclosures for complete benchmark descriptions are available upon request. REPORTING CURRENCY Valuations are computed and performance is reported in U.S. dollars. FEES The Net of Fees return is the Gross of Fees return reduced by the actual investment management fee incurred by each portfolio in the Composite. INTERNAL DISPERSION Internal dispersion is calculated using the asset weighted standard deviation of annual gross returns of the portfolios that were in the composite for the entire year. Internal dispersion is not calculated if the composite contains less than five portfolios at period end. SIGNIFICANT CASH FLOW POLICY Effective January 21, any portfolio in the Full Market High Yield composite with a cash flow over 15% of the beginning market value is removed from the Composite for the month of the cash flow. ANNUALIZED STANDARD DEVIATION The three-year annualized standard deviation measures the variability of the Composite and the benchmark returns over the preceding 36-month period. The standard deviation is not required for periods prior to

10 Neuberger Berman Europe Limited Lansdowne House 57 Berkeley Square London, W1J 6ER, United Kingdom Neuberger Berman Investment Funds plc. (the Fund ) is authorised by the Central Bank of Ireland (the Central Bank ) as an Undertaking for Collective Investment in Transferable Securities under the European Communities ( UCITS ) Regulations 211 (S.I. 352 of 211) of Ireland, as amended. The fund mentioned in this document may not be eligible for sale in some countries and it may not be suitable for all types of investors. Shares in the fund may not be offered or sold directly or indirectly into the United States or to U.S. Persons; for further information see the current prospectus. The Fund is registered in a number of countries; please see the latest Country Registration Matrix on We do not represent that this information, including any third-party information, is accurate or complete and it should not be relied upon as such. Opinions expressed herein reflect the opinion of Neuberger Berman Europe Limited ( NB Europe ) and are subject to change without notice. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned herein. No part of this document may be reproduced in any manner without the written permission of NB Europe. Shares in the Fund are offered only on the basis of the information contained in the prospectus, key investor document and the latest audited annual accounts and any subsequent half-yearly accounts of the Fund. Copies are available free of charge from the Manager at the address below or can be found on RISK CONSIDERATIONS Past performance is not indicative of future results. For details of the investment risks, see the current prospectus. Please note that any dividends which the Fund may receive may be subject to withholding tax. The benchmark does not take into account the effects of tax and the deduction is therefore not reflected in the benchmark return illustrated herein. The investment objective and performance benchmark is a target only and not a guarantee of the Fund performance. The index is unmanaged and cannot be invested in directly. Index returns assume reinvestment of dividends and capital gains and unlike fund returns do not reflect fees or expenses. Adverse movements in currency exchange rates can result in a decrease in return and a loss of capital. Investments of each portfolio may be fully hedged into its base currency potentially reducing currency risks but may expose the portfolio to other risks such as a default of a counterparty. 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Before entering into any transaction, you should consider the suitability of the transaction to your particular circumstances and independently review (with your professional advisers as necessary) the specific financial risks as well as the legal, regulatory, credit, tax and accounting consequences of entering into such transaction. This document is issued by NB Europe which is authorised and regulated by the UK Financial Conduct Authority ( FCA ) and is registered in England and Wales, at Lansdowne House, 57 Berkeley Square, London, W1J 6ER and is also regulated by the Dubai Financial Services Authority as a Representative Office. Neuberger Berman is a registered trademark. P24 8/ Neuberger Berman. 1