Worried about stocks? High-yield bonds have room to run

Take Five with BlackRock's James Keenan, who says risks to the asset class include central bank policy

Apr 15, 2014 @ 12:01 am

By Jeff Benjamin

As the chief investment officer of BlackRock Inc.'s leveraged finance team, James Keenan views high-yield bonds and bank loans as solid portfolio ballasts.

Even though high-yield bonds gained an impressive 7.4% last year and bank loans gained 5.3%, Mr. Keenan says the economic conditions continue to favor the two categories, where he sees more room to run.

"The high-yield and bank loan markets have grown dramatically because they have looked like an attractive fixed-income asset to retail investors," he said.

Mr. Keenan said investors should still be able to expect total returns of between 4% and 6%.

Fallen off?

InvestmentNews: Why was the high-yield bond space such a hot asset class last year, and why has it fallen off a bit this year?

Mr. Keenan: I don't necessary think it has fallen off its perch, considering that it's up over 3% this year, which is pretty good in relation to equity and most fixed, in general.

With high-yield bonds you're lending to the corporate space. And as spreads get tighten, the total return potential gets reduced.

Last year was a growth market where duration assets fell off and equity markets did really well. So that was a very optimistic market for risk assets.

InvestmentNews: What's the biggest risk facing high-yield bonds at this point in the cycle?

Mr. Keenan: I would say it's not a high-yield factor or a corporate factor. The risk still has to do with macro factors, including global monetary policy.

The corporate space has still been very conservative. The biggest risk factors today are still some of the unwinding of central bank policies as they become more hawkish.

InvestmentNews: What about the impact of tapering and the next stage of rising interest rates?

Mr. Keenan: The tapering is out there, and it's accepted by the market. The market has priced in that this Federal Reserve is moving off quantitative easing.

Now, whether we have an increase in rates or not raises a couple of questions. The steepness of the curve is clearly important. Then there's the question of how much and why rates are moving.

If the front end starts to move because the economy is getting better, that could introduce volatility.

But the bank loan market is a floating-rate market, so it is still mostly hedged in a rising-rate environment.

High-yield is a little more duration sensitive. Higher rates might not be negative to the market if it means the economy is doing better.

But lending is cyclical, too. And as we've seen in past cycles, if there is more demand, you might see some deals get riskier.

InvestmentNews: How should investors compare high-yield bonds to bank loans funds?

Mr. Keenan: A mortgage is a first lien on a home that's usually issued by a bank. Bank loans are traditionally the same thing. It's secured on the capital structure.

Historically, recovery rates of secured loans are between 75 and 80 cents on the dollar.

In the case of high-yield, you move down the capital structure, where you are still senior to equity but junior to bank debt.

InvestmentNews: With what you've seen so far this year, what's your outlook for the rest of 2014?

Mr. Keenan: We don't expect high total returns in high yield, but it provides a good solution — a good way to get 4% to 6% total return.

When assets start to trade closer to fair value and at higher multiples, your volatility can come back.

You have situations like the rising risks involving Ukraine, a slowdown in China, and U.S. Fed policy. But nothing has changed our view with regard to high-yield. There are things that have introduced some volatility, but not tail risk.

Volatility has been in the interest rate market and the equity market.

You want to sell high-yield bonds when you want to sell equities. At the end of the day, a high-yield bond is a loan with a company, and the ability of that company to pay you back is dependent on that company's ability to generate cash flow.


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