Institutional investor enthusiasm for high yield has led the category to its best quarter in several years after distress caused by the fallout from the Covid-19 pandemic created opportunities for buyers.
US active high-yield fixed income strategies recorded more than $25bn in net institutional flows during the second quarter, bringing institutional assets under management in the strategy tracked by eVestment up to $555bn.
The turnround follows a period of net outflows for nearly every quarter since the first quarter of 2017, with the exception of the third quarter of 2018, when the category drew $2.2bn in net inflows.
The huge inflows in the second quarter compare to institutional net outflows of $8bn during the first quarter of 2020 and $4bn in net outflows during the same quarter last year.
High yield is a lot more attractive than it has been in a very long time, said Mike Fontaine, director of credit manager research at Willis Towers Watson. Many investors, including Willis Towers Watson, have been waiting for an event like this to rotate capital back into high-yield fixed income strategies, he said.
“People were waiting to kind of pounce on a dislocation,” Mr Fontaine said. “I think with the market selloff, you saw spreads get over a thousand basis points. You saw spreads that you haven’t reached, really, since 2008 or 2009.”
Despite outflows over the past few years, investors still saw high-yield strategies as possessing the potential to be a valuable income generating part of the portfolio, Mr Fontaine said. Though the market for active high yield was most attractive at the end of March, there are still opportunities, he added.
“Up until, let’s say, the end of last year, very few people had a dedicated ‘fallen angels’ mandate,” Mr Fontaine said, referring to bonds that have fallen from investment grade to junk bond status. “There’s just great potential for outperformance for these names. We’re starting to see more people accepting it.”
When these companies are downgraded, it creates outsized selling pressure and a subsequent price drop for these bonds. An opportunity then emerges for some asset managers to buy these bonds at the new depressed price and “ride the upswing back”, he explained.
The number of these fallen angels have led some asset managers to launch new active high-yield products or think about launching new investment products, Mr Fontaine said
“From what we see in our pipeline, I do think [the demand] will continue,” said David Mihalick, head of US public fixed income at Barings. “I think we have seen a backup recently, but that has been more in the higher quality parts of the market where things have gotten really tight.”
The economic uncertainty has led to sell-offs across various sectors, some of which are recovering or will recover due to a pickup in some sectors of the economy. Other sectors will probably face permanent damage and default, Mr Mihalick said. During this period, active management can see the differences, he said.
High yield has been one of the few places where active management still makes sense and is “cheap” on a relative basis, which is why institutional capital continues to flow, he added.
“[Investors] want to understand how [active managers] think through various sectors and run scenario analysis in terms of how long businesses can go with the liquidity they have,” Mr Mihalick said.
The distress in the market at the end of the first quarter and early days of the second quarter attracted various institutional pools of capital including specialist credit mandates and special situations investors, said Andrew Jessop, high yield portfolio manager at Pimco.
While the market has balanced out a bit since the second quarter, there is still demand from spread-oriented buyers or the typical investment-grade crossover buyers even if traditional high-yield buyers stay on the sidelines, he said.
Despite the opportunities, the high-yield market still carries a lot of risk. Many of the widest spreads are associated with airlines, leisure and entertainment companies and cruise lines that were heavily impacted by the pandemic, Mr Jessop said. Some of these companies might end up with too much debt relative to future earnings power, he added.
Managing a high-yield mandate can be more tricky now than it was in March, because of the riskier companies in the space that might default, said William Beck, senior vice president at Wilshire, the asset manager and consulting group. As a result, some investors have opted to open up high-yield mandates to also include more opportunistic credit searches, he said. “Not wanting to take undue risk to chase yield,” may be impeding some of demand these days, he added.
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