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April 2019 | GSAM Connect

US High Yield: Return Potential Arising from Demand Dynamics

Demand: Rotation from Loans to High Yield

US High Yield funds have reported strong inflows so far this year—with $1.9bn entering the asset class in March—on improved investor sentiment following volatility in late 2018. In contrast, US leveraged loan funds have experienced sizeable investor outflows, with the US Federal Reserve’s (Fed) pivot toward a patient approach with respect to future rate hikes reducing the appeal of floating-rate investments.

Returns: Potential Opening up in Smaller Bonds

  • Firm investor demand has been a large contributor to solid total returns for US High Yield this year. However, within the sector, we observe dispersion in performance between bonds from small and large issues. Small issues are generally defined as below $500mn in notional amount, while larger issues range from $500mn to $1bn, though they may also exceed $1bn. 

  • Performance dispersion has arisen due to the nature of retail fund demand; much of this demand is channeled through ETFs, for which larger bonds tend to be eligible. Smaller bonds are not typically eligible for ETF inclusion and have therefore not benefited to the same degree as larger bonds from recently reignited retail interest in the sector. This is evidenced by lower total returns for smaller bonds year-to-date (YTD) and less spread retracement following late 2018 widening. 

  • Given this divergence, we screened the high yield market in search of attractive spread premiums on offer among smaller bonds. We added modest exposure to bonds from smaller issues (with an average credit rating of B-) while scaling back exposure to longer-dated BB-rated bonds which had outperformed YTD and where valuations now appeared extended. In our view, there is potential for spreads on these smaller bonds to tighten relative to larger bonds. They also tend to be less sensitive to sharp—and sometimes abrupt—changes in retail investor demand.   
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March 2019 | GSAM Connect
Keep Calm and “Carry and Roll” On

This month we focus on curves. In credit markets we outline how curve steepness can create return opportunities within the sector and within a particular rating cohort, namely BBB-rated bonds. On the macro front we discuss why we believe the business cycle signal implied by yield curve inversion is less powerful than in prior cycles.