It’s easy to say things are bad right now, whether that be socially or economically. It’s also easy to say things look set to stay that way for quite a while.

However, as portfolio managers, we are paid to be a little more insightful. It is our job to determine what is priced in and seek out where the best opportunities lie.

What is priced in?

The default rate topped 15% in the Global Financial Crisis, however, the actual loss given default was just above 7%. At this moment in time high yield spreads are around 750bps and taking the historic recovery rate of 40% gets you to a default rate of 12.5%. Although spreads on global high yield actually blew out to around 2,150bps during the GFC, which implied a default rate of 36%, we know the high yield market typically overcompensates for defaults. So in short, we have a lot of default risk priced in to the asset class right now versus historic realised default cycles.

Where are the interesting opportunities?

The secured deals of some unloved credits such as Viking Cruises and Sally Beauty, is an area where opportunities are arising. As more and more businesses seek rescue financing, the investment decision as a bondholder should not be viewed as one that is similar to an equity holder’s thesis.

Clearly we are paid to make judgements on the value of the underlying security being offered in these deals, and it is often the case that we will still elect to demur on the opportunities presented to us. However, it can certainly be argued that the increased prevalence of high yield bondholders being offered this additional improved security has been one of the (small number) of positives to have emerged from the crisis.

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