Show Transcript
Falling U.S. interest rates may lead some investors to take a closer look at the high-yield bond market. Anthony Imbesi, Vice President and Director for High Yield Portfolio Management at TD Asset Management, speaks with MoneyTalk’s Greg Bonnell about the opportunities and potential risks.
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[AUDIO LOGO]
In a falling interest rate environment, investors may be considering the potential opportunities in fixed income. Joining us now to discuss how things look in the high yield space is Anthony Imbesi, VPN Director for High Yield Portfolio Management at TD Asset Management. Anthony, welcome to the program.
Thanks for having me, Greg.
All right. Your first time here. We do this with a first time guest. We get them to tell a little bit about their work and what they do here, here at the bank, and part of the strategy for the audience.
Well, as you mentioned, I'm a portfolio manager. I've been with TD Asset Management 8 and 1/2 years. And I'm responsible for the fixed income mandates, in particular the high yield sleeves of the portfolios that we manage in the active fixed income team.
Obviously, high yield can be an interesting space and perhaps one that is not well understood by investors when you start talking about fixed income. So give us an overview of the high yield market. What is it comprised of?
Well, the high yield market is essentially any debt, whether it's bonds or loans, that's rated below investment grade. So anything with a Triple B-minus rating or lower is considered high yield or leveraged credit. And it's quite a big market. The US dollar market is about $1.3 trillion in size. If you include a euro denominated high yield, and emerging markets, and leveraged loans, you can get to $3 and 1/2 trillion. And if you throw in private credit or direct lending, it gets to about $5 trillion or greater. So that's a pretty big market. It's significant. And it's one that shouldn't be ignored.
When people refer to the high yield market, a common term that we hear--
You might know it by a different name, right?
Exactly, junk. Junk bonds. Right? It's thrown out by the media a lot. But essentially, it can be misleading because a lot of these companies, every asset class has good quality companies and lower quality companies. High yield is no exception. And within that space, I think what's important to know is you can find good companies that might be rated high yield that can make perfect sense for a fixed income portfolio.
So when we look at the high yield market, one of the things we do is we screen out all these potential lower quality names and do our analysis. But effectively, it's a market that should be considered for any investors in their high yield portfolio. And when we-- again, talking about junk bonds-- it's an important market for issuers. If you can issue in the investment grade market, this is the market where companies can access capital and grow their businesses.
Some companies have actually grown to become investment grade over time, while others have remained high yield. And there's nothing wrong with that. For example, when we look at-- I'll name some companies for you. Ford Motor Credit, or Ford Motor, for example, Kraft, Heinz, T-Mobile, Netflix, Uber, Tesla in the US and in Canada, National Bank, Laurentian Bank, Air Canada, Bombardier, Rogers, Quebecor, all these companies have or have had at one point high yield.
I'm actually surprised to hear that. I mean, these are some big name companies on both sides of the border.
Exactly. So if you paint the entire asset class with the same brush, you're really missing out on these opportunities. Because if you think about it, a lot of investors might own some of the equities, either directly or indirectly. Institutions own the equities of these companies. And yet if things went really badly, if you got into a bankruptcy or a restructuring scenario, you would much rather be a bondholder than an equity holder because bondholders get paid off first before any residual value gets allocated to the equity holders.
And don't forget, this high yield market, it's a market that's invested by institutions such as pension funds, sovereign wealth funds, insurance companies. They do it to enhance their income, improve their returns.
All right. Let's talk about nice breakdown of what the space is, a better understanding of the space. Probably people in the audience would be saying, I had no idea some of those companies either are or used to be. Let's talk about the opportunity there are. I believe you have some charts for us in terms of how the space has performed.
Yeah, there's definitely opportunities in high yield. I'll highlight some quickly here. Obviously, return is the big one. High yield has had compelling returns historically. It has outperformed pretty much every major fixed income asset class that we've seen. The bars on the left, I guess, of that graph, just show you how it compares with the more safer or deemed safer investment grade corporate bonds or even treasuries or government bonds, which you can see here.
Let's just look at investment grade compared to high yield. Over time, over 20 years, an annually, you can get up to 200 basis points or more or the market has delivered 200 basis points or more of excess returns than those asset classes. And when you compound that, that can really make a difference in the outcomes of investors portfolios. And a lot of people say, well, what about the risks? Or yes, you can get certain returns but the price volatility.
So I guess this graph here, we indicate-- we adjust for that. So what we're doing is we're showing the returns for the asset classes, for a few asset classes. And we're showing the volatility. And then, we're just taking the ratio between that. And you can see loans and high yield, again this is leveraged credit, comes out ahead of the other asset classes. So in other words, you're getting more return for that given amount of volatility, which again makes it a more compelling argument to consider, high yield or leveraged credit, as part of your fixed income solution.
Do we have one more picture for the audience? I can't remember if we had two or if we had three.
I think that was it.
That was it?
That was--
Yeah, they were nice pictures.
Yeah, the best benefit, I guess, is returns. But there's other benefits, like diversification. So when you compare-- if you just limit yourself to Canadian investment grade corporates, you're really limiting yourself to a much smaller market. But if you start including high yield into that, you're giving yourself access to a market that's four and a half times the size, actually over it's over times the size, but four and a half times more companies to choose from and over 25 different industries.
For example, Canadian IG, 35% of the market is just financials, financial related companies. Financials and utilities make up 50% of the market. And then if you throw in energy, that's almost 2/3 of the Canadian corporate investment grade market. You can't really diversify your portfolio with those three sectors. Bringing in high yield gives you that opportunity.
Another thing is duration. Duration is much lower in high yield than it is in your investment grade bonds. The reason is, typically, high yield bonds have a 5- to 10-year maturity. And they're also callable. So they never really get to that maturity, which means you have a shorter duration period and therefore less sensitivity to interest rate risk.
Let's talk about some of the risks there. Because obviously, I mean, yield usually reflects risk and risk premiums. So the yields are higher. What do we need to be aware of on the risk side?
Right, good point. Like every asset class, there's always risks involved. With high yield, particularly, I think credit risk is the big one. I mean, you are taking on credit risk by investing in high yield. And when we talk about credit risk, there's different components of it. The big one is default risk. Default risk is just really when a company misses a coupon payment or just can't pay its principal back at maturity.
Other types of default risk are that we're seeing more these days are distressed debt exchanges. And that occurs when a company offers to exchange its existing bonds, again, this company is in distress. The bonds are trading at the stress levels for new bonds. And it entices bondholders to kind of accept that deal with the alternative being, well, if you don't, we can go through a restructuring, a chapter 11 bankruptcy, and take your chances there.
Sometimes the outcomes are worse out of a chapter 11 bankruptcy. Sometimes they're better. But what it gives the bondholders the option of is to value the proposal and say, well, OK, fine, we can take a bit of a discount or a haircut today, keep the company alive. We extend the bond maturity. The company lives to operate another day and continues as a going concern for the benefit of not going through chapter 11 restructuring. [AUDIO LOGO]
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In a falling interest rate environment, investors may be considering the potential opportunities in fixed income. Joining us now to discuss how things look in the high yield space is Anthony Imbesi, VPN Director for High Yield Portfolio Management at TD Asset Management. Anthony, welcome to the program.
Thanks for having me, Greg.
All right. Your first time here. We do this with a first time guest. We get them to tell a little bit about their work and what they do here, here at the bank, and part of the strategy for the audience.
Well, as you mentioned, I'm a portfolio manager. I've been with TD Asset Management 8 and 1/2 years. And I'm responsible for the fixed income mandates, in particular the high yield sleeves of the portfolios that we manage in the active fixed income team.
Obviously, high yield can be an interesting space and perhaps one that is not well understood by investors when you start talking about fixed income. So give us an overview of the high yield market. What is it comprised of?
Well, the high yield market is essentially any debt, whether it's bonds or loans, that's rated below investment grade. So anything with a Triple B-minus rating or lower is considered high yield or leveraged credit. And it's quite a big market. The US dollar market is about $1.3 trillion in size. If you include a euro denominated high yield, and emerging markets, and leveraged loans, you can get to $3 and 1/2 trillion. And if you throw in private credit or direct lending, it gets to about $5 trillion or greater. So that's a pretty big market. It's significant. And it's one that shouldn't be ignored.
When people refer to the high yield market, a common term that we hear--
You might know it by a different name, right?
Exactly, junk. Junk bonds. Right? It's thrown out by the media a lot. But essentially, it can be misleading because a lot of these companies, every asset class has good quality companies and lower quality companies. High yield is no exception. And within that space, I think what's important to know is you can find good companies that might be rated high yield that can make perfect sense for a fixed income portfolio.
So when we look at the high yield market, one of the things we do is we screen out all these potential lower quality names and do our analysis. But effectively, it's a market that should be considered for any investors in their high yield portfolio. And when we-- again, talking about junk bonds-- it's an important market for issuers. If you can issue in the investment grade market, this is the market where companies can access capital and grow their businesses.
Some companies have actually grown to become investment grade over time, while others have remained high yield. And there's nothing wrong with that. For example, when we look at-- I'll name some companies for you. Ford Motor Credit, or Ford Motor, for example, Kraft, Heinz, T-Mobile, Netflix, Uber, Tesla in the US and in Canada, National Bank, Laurentian Bank, Air Canada, Bombardier, Rogers, Quebecor, all these companies have or have had at one point high yield.
I'm actually surprised to hear that. I mean, these are some big name companies on both sides of the border.
Exactly. So if you paint the entire asset class with the same brush, you're really missing out on these opportunities. Because if you think about it, a lot of investors might own some of the equities, either directly or indirectly. Institutions own the equities of these companies. And yet if things went really badly, if you got into a bankruptcy or a restructuring scenario, you would much rather be a bondholder than an equity holder because bondholders get paid off first before any residual value gets allocated to the equity holders.
And don't forget, this high yield market, it's a market that's invested by institutions such as pension funds, sovereign wealth funds, insurance companies. They do it to enhance their income, improve their returns.
All right. Let's talk about nice breakdown of what the space is, a better understanding of the space. Probably people in the audience would be saying, I had no idea some of those companies either are or used to be. Let's talk about the opportunity there are. I believe you have some charts for us in terms of how the space has performed.
Yeah, there's definitely opportunities in high yield. I'll highlight some quickly here. Obviously, return is the big one. High yield has had compelling returns historically. It has outperformed pretty much every major fixed income asset class that we've seen. The bars on the left, I guess, of that graph, just show you how it compares with the more safer or deemed safer investment grade corporate bonds or even treasuries or government bonds, which you can see here.
Let's just look at investment grade compared to high yield. Over time, over 20 years, an annually, you can get up to 200 basis points or more or the market has delivered 200 basis points or more of excess returns than those asset classes. And when you compound that, that can really make a difference in the outcomes of investors portfolios. And a lot of people say, well, what about the risks? Or yes, you can get certain returns but the price volatility.
So I guess this graph here, we indicate-- we adjust for that. So what we're doing is we're showing the returns for the asset classes, for a few asset classes. And we're showing the volatility. And then, we're just taking the ratio between that. And you can see loans and high yield, again this is leveraged credit, comes out ahead of the other asset classes. So in other words, you're getting more return for that given amount of volatility, which again makes it a more compelling argument to consider, high yield or leveraged credit, as part of your fixed income solution.
Do we have one more picture for the audience? I can't remember if we had two or if we had three.
I think that was it.
That was it?
That was--
Yeah, they were nice pictures.
Yeah, the best benefit, I guess, is returns. But there's other benefits, like diversification. So when you compare-- if you just limit yourself to Canadian investment grade corporates, you're really limiting yourself to a much smaller market. But if you start including high yield into that, you're giving yourself access to a market that's four and a half times the size, actually over it's over times the size, but four and a half times more companies to choose from and over 25 different industries.
For example, Canadian IG, 35% of the market is just financials, financial related companies. Financials and utilities make up 50% of the market. And then if you throw in energy, that's almost 2/3 of the Canadian corporate investment grade market. You can't really diversify your portfolio with those three sectors. Bringing in high yield gives you that opportunity.
Another thing is duration. Duration is much lower in high yield than it is in your investment grade bonds. The reason is, typically, high yield bonds have a 5- to 10-year maturity. And they're also callable. So they never really get to that maturity, which means you have a shorter duration period and therefore less sensitivity to interest rate risk.
Let's talk about some of the risks there. Because obviously, I mean, yield usually reflects risk and risk premiums. So the yields are higher. What do we need to be aware of on the risk side?
Right, good point. Like every asset class, there's always risks involved. With high yield, particularly, I think credit risk is the big one. I mean, you are taking on credit risk by investing in high yield. And when we talk about credit risk, there's different components of it. The big one is default risk. Default risk is just really when a company misses a coupon payment or just can't pay its principal back at maturity.
Other types of default risk are that we're seeing more these days are distressed debt exchanges. And that occurs when a company offers to exchange its existing bonds, again, this company is in distress. The bonds are trading at the stress levels for new bonds. And it entices bondholders to kind of accept that deal with the alternative being, well, if you don't, we can go through a restructuring, a chapter 11 bankruptcy, and take your chances there.
Sometimes the outcomes are worse out of a chapter 11 bankruptcy. Sometimes they're better. But what it gives the bondholders the option of is to value the proposal and say, well, OK, fine, we can take a bit of a discount or a haircut today, keep the company alive. We extend the bond maturity. The company lives to operate another day and continues as a going concern for the benefit of not going through chapter 11 restructuring. [AUDIO LOGO]
[MUSIC PLAYING]
