High yield bond investors are licking wounds incurred during a tumultuous 2015, as the asset class returned negative 4.64%, its first down year since the -26.39% drubbing amid the market meltdown of 2008. Of course, with every selloff, market players try to gauge when the assets in question reach a level where they represent an opportunity, instead of a problem. To that point, high yield expert Martin Fridson says last year's rout has left the market close to what he terms fair value.
"The option-adjusted spread (OAS) on the BAML High Yield index widened from 504 bps to 695 bps during the course of 2015. Fair value was a moving target, however, increasing from 522 bps on Dec. 31, 2014, to 719 bps on Nov. 30, 2015. (The Dec. 31 fair value estimate will not be available until mid-January, when Industrial Production and Capacity Utilization are released.) At the end of December, the high-yield market was close to fair value."
The 2015 sell-off hit certain sectors particularly hard, of course, so the oil & gas and commodities segments merit attention re fair value. Fridson:
"An important caveat to this conclusion is that the BAML High Yield Index’s OAS is currently skewed by extraordinarily wide spreads in Energy and Metals & Mining. In normal times these industries do not trade far out of line with the overall index, but as of Dec. 31 their option-adjusted spreads are 1,415 and 1,498 bps, respectively. By our calculation, the rest of the BAML High Yield Index has a spread of only 576 bps. That puts the non-Commodity high-yield universe 143 bps below fair value. That qualifies as extreme overvaluation according to our methodology, as it exceeds a divergence of one standard deviation (126 bps)."
You can read more about high yield bond fair value, and how it is calculated, here. Also of note in 2015, Fridson says: High yield bond investors venturing to the lower levels of the risk spectrum did so to their clear detriment. Bond assets rated CCC or worse returned a dismal negative 15.02% during the year, dragging down high yield returns overall. - Tim Cross
The analysis cited in this story is taken from Marty's weekly analysis for LCD News, available to subscribers here.