HIGH YIELD & RISING RATES

Transcription

1 LM Market Insight: HIGH YIELD & RISING RATES MAY 2015 THIS MATERIAL IS ONLY FOR DISTRIBUTION IN THOSE COUNTRIES AND TO THOSE RECIPIENTS LISTED. PLEASE REFER TO THE DISCLOSURE INFORMATION ON THE FINAL PAGE. IN THE UNITED STATES -

2 The prospect of rising rates: a concern for 2015 Bond yields rose sharply in reaction to the Fed s first statements in May 2013 about unwinding QE That re-focused many investors on the potential impact of rising rates and on shorter duration instruments that could be less sensitive to future interest movements such as high yield As of mid-may 2015, bond yields were up notably from recent lows in January yr US Treasury yield: 12/31/12 5/13/15 10yr UST yield (%) Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Nov 13 Dec 13 Jan 14 Feb 14 Mar 14 Apr 14 May 14 Jun 14 Jul 14 Aug 14 Sep 14 Oct 14 Nov 14 Dec 14 Jan 15 Feb 15 Mar 15 Apr 15 Source: Bloomberg, as of 5/13/15. The 10-yr Treasury yield is from the US Treasury constant maturity series. Past performance is no guarantee of future results. Yields represent past performance and there is no guarantee they will continue to be paid. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 2

3 Rate changes may not impact all bond sectors the same way Higher yielding bond sectors tend to behave very differently than core sectors High yield (HY) bonds, bank loans and emerging market (EM) credit have historically shown low or negative correlation to U.S. Treasuries and other investment-grade sectors High yield, in particular, may react differently than lower-yielding sectors 10-year correlation of select fixed-income sectors Source: Bloomberg, as of 4/30/15. See page 11 for index definitions. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 3

4 A relevant difference for HY: shorter duration Bonds with higher coupon payments tend to reduce duration, or interest rate risk. Why? Duration is the weighted average of all the present values for a bond s cash flows both coupon payments and the final payment of principal The higher the coupon, the greater contribution it will likely make to duration relative to the final principal payment, which (because it comes at the end) has the most interest rate risk. Average duration of select fixed-income sectors US High Yield EM Loc Cur Govt Asian Pacific X Japan US Aggregate EM US$ Corp US Treasury US Corporate US Corporate US Treasury EM US$ Corp US Aggregate Asian Pacific X Japan EM Loc Cur Govt US High Yield Source: Barclays, as of 5/13/15. See page 11 for index definitions. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 4

5 US HY offers a substantial yield premium US HY bonds currently offer considerably higher yield than investmentgrade fixed-income sectors, having made them an attractive source of income Of course, HY also exposed investors to greater default risk and price volatility Yield (%) Yields of select fixed-income sectors 7 Investment grade sectors US Treasury US Aggregate Asian Pacific Non Japan US Corporate EM US$ IG Corporate LSTA Bank Loans EM Local Currency Govt US High Yield Source: Barclays and Bloomberg, as of 2/20/15. See page 11 for index definitions. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 5

6 And a history of positive results when rates increased Higher income and lower duration have been the main reasons high-yield bonds have generated positive total returns in years when interest rates increased. Total returns in years when interest rates increased Increase in 10 year Treasury yield Annual total returns (%) Year Basis Points US Treasuries Bank Loans High Yield N/A N/A Sources: U.S. Department of the Treasury, Morningstar Direct. See page 11 for index definitions. Past performance is no guarantee of future results. Bank loan performance is not available prior to U.S. Treasuries are represented by the Barclays U.S. Treasury Bond Index. Bank Loans are represented by the S&P/LSTA Performing Loan Index. High Yield is represented by Barclays U.S. Corporate High-Yield 2% Issuer Cap Index. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 6

7 However, NOT all HY bonds are created equal HY coupon, yield and duration vary significantly by credit quality Comparative metrics for HY credit sectors 10.0 Default rates vary greatly based on sector and fundamentals of the issuer Security selection thus plays a huge role in HY investment performance having opened the door for active managers Avg Duration (years) Yield (%) Avg Coupon (%) Ba B Caa Source: Barclays, as of 5/13/15. See page 11 for index definitions. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 7

8 High yield fundamentals are currently favorable Current conditions in the high yield market are relatively favorable Default rates are well below average and are currently forecast to remain there throughout 2015 An investment process focused on individual security analysis may be well-suited for the current environment High yield default rate Default rate (%) Annual default % 4Q 2015 forecast Avg Source: Moody s, as of 3/31/2015. See page 11 for index definitions. Past performance is no guarantee of future results. Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 8

9 Higher yield, lower duration: an attractive combination in today s environment Yield & average duration of select bond sectors HY bonds have the potential to help address investor demands for attractive income with reduced sensitivity to future rate changes Yield (%) US High Yield Asian Pacific Non Japan EM Local Currency Govt EM US$ Corp US Aggregate US Corporate 1 US Treasury Average duration (years) Source: Barclays, as of 5/13/15. See page 11 for index definitions. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment. Page 9

10 Investment risks: The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice. Fixed income securities are subject to interest rate and credit risk, which is a possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. As interest rates rise, the price of fixed income securities falls. High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. U.S. Treasuries are direct debt obligations issued and backed by the full faith and credit of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities. Active Management does not ensure gains or protect against market declines. Yields represent past performance and there is no guarantee they will continue to be paid. Page 10

11 Index Definitions: In the preceding charts US Treasury is represented by the Barclays U.S. Treasury Index, which is the U.S. Treasury component of the U.S. Government index. US Aggregate is represented by the Barclays U.S. Aggregate Bond Index, which is an unmanaged index of U.S. investment-grade fixedincome securities. US Corporate is represented by the Barclays US Corporate Index, which is the corporate component of the U.S. Credit index. Asian Pacific Non Japan is represented by the Barclays Asian-Pacific Non-Japan Aggregate Index, which is the Asian-Pacific Non-Japan component of the Asian Pacific Aggregate index. Emerging Market (EM) US$ Corporate is represented by the Barclays EM USD Corporate and Quasi-Sovereign Investment Grade Index, which is the corporate and quasi-sovereign component of the Barclays EM USD Aggregate Index, which is a hard currency Emerging Markets debt benchmark that includes USD denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Bank loans are represented by the S&P/LSTA U.S. Leveraged Loan 100 Index, which is designed to reflect the performance of the largest facilities in the leveraged loan market. A bank loan or leveraged loan is a loan provided to a company already holding a considerable amount of debt. Standard & Poor's (S&P) is an American financial services company that publishes financial research and analysis on stocks and bonds and is also known for its stock market indices such as the U.S.-based S&P 500. LSTA stands for Loan Syndications and Trading Association, which is the trade association for corporate lending and loan trading, dedicated to advancing the interests of the marketplace as a whole. EM Local Currency Govt is represented by the Barclays Emerging Markets Local Currency Government Index, which is designed to provide a broad measure of the performance of local currency emerging markets (EM) debt. US High Yield is represented by the Barclays U.S. Corporate High Yield Index, which covers the universe of fixed rate, non-investment grade debt, including corporate and non-corporate sectors. In the performance table on slide 6, US High Yield is represented by the Barclays U.S. Corporate High-Yield 2% Issuer Cap Index, which tracks the 2% Issuer Cap component of the Barclays U.S. Corporate High Yield Index, which covers the U.S. dollar-denominated, non-investment-grade fixed-rate, taxable corporate bond market. Page 11

12 Definitions of terms: A bank loan or leveraged loan is a loan provided to a company already holding a considerable amount of debt. A basis point is one one-hundredth (1/100, or 0.01) of one percent. Correlation is a statistical measure of the relationship between two sets of data. When asset prices move together, they are described as positively correlated; when they move opposite to each other, the correlation is described as negative. If price movements have no relationship to each other, they are described as uncorrelated. Coupon is the periodic interest payment made to the bondholders during the life of the bond. Credit Quality is a measurement of a bond issuer's ability to pay interest on the bond in a timely manner; it informs investors of an investment s credit worthiness, or risk of default. The credit quality ratings provided by ratings agencies such as Standard and Poor s (S&P), Moody s Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest). Please see or for details. Default rate refers to the rate at which debt holders default on the amount of money that they owe. Duration is a measure of the price sensitivity of a fixed-income security to an interest rate change of 100 basis points. It is calculated as the weighted average of the present values for all cash flows. The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments. An investment-grade rating (AAA, AA, A, BBB for example) is one that indicates that a municipal or corporate bond has a relatively low risk of default. Bonds with below investment-grade ratings (BB, B, CCC for example) are considered low credit quality and have a higher risk of default. Leverage refers to the amount of debt held by a company or sector of the market. Liquidity refers to the degree to which an asset or security can be bought or sold in the market without affecting the asset's price. Quantitative easing (QE) refers to a monetary policy implemented by a central bank in which it increases the excess reserves of the banking system through the direct purchase of debt securities. Tapering refers to the Fed s announced approach to reduce the pace of its current $85 billion in monthly asset purchases gradually instead of ending the purchases all at once. The U.S. Treasury Department is responsible for issuing all Treasury bonds, notes and bills; it is responsible for the revenue of the U.S. government. The yield curve shows the relationship between yields and maturity dates for a similar class of bonds. Yield premium refers to the additional yield an investor receives from a higher yielding investment than from a lower yielding investment. Yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting. Page 12

13 Important information: This material is for information only and does not constitute an invitation to the public to invest in any funds, securities, strategies or other products. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. All investments involve risk, including possible loss of principal. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. 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