Growing interest rate risk is turning high-yield managers' focus to short-duration high-yield corporate bonds and could soon prompt these managers to part with longer-dated paper.
Sources said that increasing government bond yields, which hit 1.66% March 17 up from less than 1% at the start of 2021, are a sign of increasing rates, which is making longer-dated high-yield bonds weak links in high-yield portfolios. Lower-quality credits such as high-yield bonds, which tend to be shorter duration, will perform better in periods of increasing rates. Conversely, longer-duration bonds will see prices drop as interest rates increase.
Among long-duration high-yield bonds are those that were downgraded to junk status — or BB — from investment-grade, managers said. These bonds are known as fallen angels.
Due to rates sensitivity, Andrzej Skiba, head of U.S. credit at BlueBay Asset Management LLP in Stamford, Conn., said fallen angels could have lost the charm they had in the second half of 2020 when rates were lower.
But high-yield managers aren't yet selling fallen angels back to investment-grade managers that are also able to hold junk paper, even though some of these managers are looking for yield by riding an expected upgrades wave in 2021 and 2022.
That's because the upgrade wave is expected to stretch out in time.
Sunita Kara, high-yield portfolio manager at Aviva Investors Global Services Ltd. in London, said: "It's a bit of a tricky situation." The prospect of corporate earnings improvement has been muddled by rate volatility, she said. "Therefore, identifying companies and playing 10-year (bonds) on that curve once that upgrade is through would lead to spread compression," she added.
"Up until then we could have raising rates going against us," she added. Aviva has £366 billion ($506 billion) in assets.