However, this short-dated nature generally means that issuers must refinance their bonds more frequently, and hence will feel the impact of higher rates far quicker than investment-grade issuers. That creates financing risk, compounding their already risky nature.
This year and 2024 do not look too challenging in terms of the volume of maturities, but a large proportion of debt matures in 2025. About 16 per cent of European high-yield bonds (excluding financials) will mature in two years’ time — six times more than in 2023.
Central banks have made it clear that the bar for rate cuts will be high, so it is likely that bonds issued in the coming years will be more expensive for issuers than those they are replacing. Investment-grade issuers, on the other hand, will refinance at a much slower rate, meaning the pass-through of higher rates to their costs will be a much slower process.
That being said, it is worth watching for companies with large inflation-linked debts, as clearly this has become significantly more burdensome and has already tripped up some companies recently.
As alluded to earlier, high-yield issuers tend to be in a weaker financial position or have more cyclical earnings than investment-grade issuers. If the economic environment becomes tougher, company earnings will come under pressure.
Investment-grade issuers certainly will not be immune, yet their more robust financial position means they are more likely to be able to weather such a period without debt affordability becoming an issue.
High-yield spreads do not look obviously cheap, given that risk, so investors will want to be selective in their exposure — unless of course they think a “soft landing” is likely, in which case the shorter duration and higher spread on offer from high-yield bonds may well appeal.
For those more concerned about central bank tightening leading to recession, the relative safety of investment-grade credit, as well its longer duration, may be more enticing.
Duration is dynamic
It is clear that higher inflation and interest rates are creating stress in the economy. The failures of several US regional banks earlier this year are cases in point.
As such, it is particularly crucial to analyse companies’ capacity to endure this economic environment: where costs are rising, sales growth is hard to come by and borrowing costs are many times what they were 18 months ago. It will also be important to identify companies that can thrive in such a climate.
Finally, remember that a bond’s duration is dynamic, in the same way as yields. As a bond’s yield rises, its duration falls.
