High-yield Bond Market Research Articles

Modeling Distress in US High Yield Mutual Funds Before and During the Covid-19 Pandemic

Abstract Research background: In March 2020, when the US financial markets were in the grip of the COVID-19 crisis, the Fed instituted various policies and programs to alleviate stress in financial markets. One such program involved the Fed purchase of securities and ETFs in certain market segments, including high yield bonds. This buying action inspired investors to join the Fed (or front-run the Fed) in the high yield bond market, resulting in the tightening of spreads in that market to historically tight levels. Purpose: In this research we investigate whether investors could have seen any signs of higher liquidity risk in US high yield mutual funds since the beginning of COVID-19 pandemic and avoid it. Theoretically, funds with heightened liquidity risk should have higher historical returns (adjusted for interest rate risk and credit risk) because borne risk requires return as compensation. But because of the unusual market conditions during the COVID-19 pandemic investors could look inside funds (to see what bonds the funds owned) and then avoid funds with holdings known to be less liquid. Research methodology: The study is based on data on US mutual funds from the Morningstar Direct database. The authors made a serial correlation model with an AR(1) process and the lagged effects model vs CAPM model to measure two proxies for liquidity risk for each US high yield mutual fund in our fund universe, in order to identify those funds at particular risk for portfolio illiquidity since the beginning of the COVID-19 pandemic. Results: it is found that the proposed measures may be an effective tool for selecting high yield funds against liquidity risk. Therefore, they should be considered by investors or analysts as a practical tool to identify funds that might be illiquid. Novelty: The study focuses on the liquidity risk in US high yield bond mutual funds before and after the outbreak of the COVID-19 pandemic, which was a crisis situation with implications for liquidity risk. The methods used and results achieved may be a basis for studies of other types of funds and markets outside the USA.

Practical Applications of Risky Corporate Bonds in 2021: A Bubble, or Rational Underwriting in a Low-Rate Environment?

In <b><i>Risky Corporate Bonds in 2021: A Bubble, or Rational Underwriting in a Low-Rate Environment?</i></b>, which appeared in the November 2021 issue of <b><i>The Journal of Portfolio Management</i></b>, authors <b>Edward Altman (Stern School of Business</b>, <b>New York University,</b> and <b>NYU Salomon Center for the Study of Financial Institutions)</b> and <b>Mike Harmon (Gaviota Advisors, LLC)</b> attempt to determine whether current market factors have driven a “bubble” in the US high-yield bond market. In order to determine whether the current market conditions in high yield truly represent those of a “bubble,” the authors analyze the highest-risk segment of this market. Based on historical average default and recovery rates, they conclude that the expected returns from the securities analyzed are not commensurate with the high risk associated with those securities. Furthermore, the authors’ analysis of key factors influencing future default and recovery rates yields the conclusion that there are more potential scenarios for investors to underperform than there are for investors to outperform. Although the conditions analyzed do not represent a true “bubble” as defined by the authors, they do express concern over other potential negative repercussions resulting from investors’ assumption of excessive risk.

Features of the high yield bond market in Russia

Features of the high yield bond market in Russia

Risky Corporate Bonds in 2021: A Bubble, or Rational Underwriting in a Low-Rate Environment?

In response to the pandemic, the Federal Reserve and US Treasury aggressively supported the corporate debt markets in 2020, both through easy monetary policy and direct participation. As the economy recovered, the Fed maintained an easy monetary policy in pursuit of more robust employment, gross domestic product growth, and inflation targets. Many observers have asserted that these policy actions and other factors have driven a bubble in risk assets, such as equities, special purpose acquisition companies, real estate, commodities, cryptocurrencies, nonfungible tokens, and risky bonds. Others believe that the valuations for at least some of these assets reflect investors’ rational incorporation of the current interest rate environment and economic outlook into their underwriting assumptions. Here, the authors analyze this question with regard to one of the riskiest classes of debt securities—the CCC-rated portion of the corporate high-yield debt market—to draw broader conclusions about the leveraged credit markets in the United States. Using historical market metrics, this portion of the market at its recent peak offered almost no excess return to compensate investors for the risk taken relative to low-risk alternatives. From this, the authors conclude that investors are underwriting significantly more optimistic outcomes than those reflected in historical averages. Although the authors believe that this segment of the market falls short of a true bubble, as they define it, they warn that current conditions pose key risks to investors and to the broader economy. <b>Key Findings</b> ▪ The US high-yield bond market, like other asset classes in the wake of the current easy monetary environment, has reached peak levels. ▪ Consistent with past bubbles, investors have moved up the risk curve, disproportionately bidding up the riskiest portion of this market. ▪ Although this reflects excessive risk appetite on the part of investors, it falls short of a true bubble as we define it. ▪ That said, these conditions pose key risks to investors and to the broader economy.

Causal nexus between crude oil and US corporate bonds

This study examines the Granger causal flow from implied oil volatility to US high-yield and investment-grade corporate bonds. The results show that the Granger causality differs over investment time horizons, with evidence of a more lasting effect for high-yield bonds. The oil price crash of mid-2014 intensifies the causal effect from oil price volatility to the high-yield bond market and its energy segment. Further analyses show that the US default risk and credit spread heterogeneously drive causalities from oil to high-yield and investment-grade bonds. These findings are useful to credit market participants for risk management and the design of appropriate asset allocation strategy. They are also important for policymakers regarding policy and regulatory formulations to manage the effects of volatility transmission.

Global Forces on the US CLO Market

This article examines the macroeconomic factors that have led the US broadly syndicated loan and collateralized loan obligation (CLO) markets to be the largest in the world then looks at how the markets evolved to the current state and explores some of the current themes facing both markets. European leveraged loans and CLOs are the second largest market, followed by US middle market loans and CLOs. Each of these markets has different challenges facing them, but there are also similarities in structures, market participants, and market forces that can benefit from shared experiences. Finally, there is the potential for a CLO market to cross over to Asia to focus on Asian credit issuance. The US broadly syndicated loan and CLO markets can serve as a benchmark for the future development of global loan and CLO markets. TOPICS:CLOs, CDOs, and other structured credit, global markets, developed markets, emerging markets Key Findings • Growth in the US leveraged loan market has been supported by sustained, but moderate, GDP growth over the past decade and monetary policy both domestically and intentionally has encourage investment in the US. • Prevalent features of the current leveraged loan market, like robust secondary market trading and covenant-lite loan structures resulting from evolution of the leveraged loan market evolving and convergence with the high yield bond market. • US capital markets continue to evolve with CLOs and private credit providing more sources of liquidity for corporate issuers.

High Yield Bond Market: Features and Risks of a Growing Market

Speculative-grade debt, in other words, debt rated below BBB or unrated debt, has had significant growth recorded in recent years, driven, among other factors, by its higher profitability compared with other investment assets, its relatively low default rates and the diverse economic sectors to which the issuers belong, which converts these securities into an attractive option for portfolio managers. The interest in these types of securities, also known as high-yield bonds, has moved somewhat to secondary markets, where the number of transactions has also increased, pushing up prices. All of this is generating a debate on the sustainability of the growth of this market. So, while some agents argue that in recent years the market for speculative debt has matured, others express doubts about whether the risks taken by investors by incorporating these high-yield, high-risk assets into their portfolios is being correctly assessed. The discussion is occurring at a time when there is clear interest at a European level in developing corporate debt markets as a source of additional corporate funding so businesses can reduce their reliance on bank financing. Given this background, this paper reviews the recent trends and the main characteristics of the markets for high-yield bonds and analyses the risk factors that could jeopardise their development and consolidation as a feasible source of funding for the real economy.

The Volatility of High-Yield Bonds Using Mixed Data Sampling Methods

It is well known that economic policy uncertainty prompts the volatility of the high-yield bond market. However, the correlation between economic policy uncertainty and volatility of high-yield bonds is still not clear. In this paper, we employ GARCH-MIDAS models to investigate their correlation with US economic policy uncertainty index and S&P high-yield bond index. The empirical studies show that mixed volatility models can effectively capture the realized volatility of high-yield bonds, and economic policy uncertainty and macroeconomic factors have significant effects on the long-term component of high-yield bonds volatility.

Risk and performance of bonds sponsored by private equity firms

Abstract The bond market is an important source of financing for Private Equity (PE) sponsored transactions. Using the methodology suggested by Bessembinder et al. (2009), we find that PE-sponsored bonds underperform comparable benchmarks. This is especially true for bonds with credit ratings below investment grade and those issued in hot bond markets. Furthermore, bonds sponsored by more experienced PE groups (PEGs) underperform bonds associated with less experienced PE groups, while bonds backed by investment bank-affiliated PEGs underperform bonds sponsored by other PEGs. These findings highlight the risk and return relationship in the high-yield bond market related to leveraged buyouts (LBOs) and PEGs.

Foundations of High-Yield Analysis

This Research Foundation brief explores various dimensions of the high-yield bond market. One contributor decomposes returns and relates risk and associated risk premiums via an econometric fair value model. Another illustrates principles of credit analysis via a case study involving a debt-financed merger. A third analytical piece focuses on forecasting the default rate. Two remaining contributions are primers — one on the corporate bankruptcy process and the other on high-yield bond covenants. The final section presents analyzes high-yield price histories as a function of macroeconomic forces, impulse forces, risk, and technical features of the time series themselves.

High-yield bond and energy markets

High-yield bonds hold a particularly unique space in the debt market. From many aspects, literature suggests these assets to behave more like stocks than bonds. Given the significant similarities between the high-yield bond and stock markets, it is expected for these markets to be similarly affected by certain outside factors. Some shocks, including the ones from energy markets, are known to impact the entire stock market and not just related company shares. Since high-yield bond portfolios include some amount of energy company debt, the recent volatility in energy prices has been particularly concerning to market participants. However, the question of whether price and volatility shocks only impact energy company bonds or the entire high-yield bond market - as they do with the stock market - still remains unanswered. This study attempts to address that question by exploring the dynamic relationships between the high-yield bond and energy markets. Price transmission tests, which account for gradual structural shifts, suggest oil and ethanol markets significantly impacting the high-yield bond market. Furthermore, volatility tests find uni-directional volatility transmitting from energy markets to the high-yield bond market.

Practical Applications of Investing in China’s High-Yield Debt Markets: A Proposed Credit Analysis Framework

Investors can find bargains in the Chinese high-yield bond market (US dollar-denominated securities that trade offshore). But, as the recent high-profile Sino-Forest bankruptcy clearly demonstrates, investors who fail to use a rigorous credit analysis process risk losing their shirts in this highly volatile and weaklyregulated market. In Investing in China’s High-Yield Debt Markets: A Proposed Credit Analysis Framework , presented in JPM’s Special China Issue , Jie Liu and Frank Fabozzi offer a new and rigorous framework, combining five credit metrics, to help investors find the most creditworthy investing opportunities in Chinese high-yield bonds.

Competition in Lending and Credit Ratings

This article relates corporate credit rating quality to competition in lending between the public bond market and banks. In the model, the monopolistic rating agency&amp;amp;#x27;s choice of price and quality leads to an endogenous threshold separating low-quality bank-dependent issuers from higher-quality issuers with access to public debt. In a baseline equilibrium with expensive bank lending, this separation across debt market segments provides information, but equilibrium ratings are uninformative. A positive shock to private (bank) relative to public lending supply allows banks to compete with public lenders for high-quality issuers, which threatens rating agency profits, and informative ratings result to prevent defection of high-quality borrowers to banks. This prediction is tested by analyzing two events that increased the relative supply of private vs. public lending sharply: legislation in 1994 that reduced barriers to interstate bank lending and the temporary shutdown of the high-yield bond market in 1989. After each event, the quality of ratings (based on their impact on bond yield spreads) increased for affected issuers. The analysis suggests that strategic behavior by the rating agency in an issuer-pays setting dampens the influence of macroeconomic shocks, and explains the use of informative unsolicited credit ratings to prevent unrated bond issues, particularly during good times. Additionally, the controversial issuer-pays model of ratings leads to more efficient outcomes than investor-pays alternatives.

Underwriter reputation and the quality of certification: Evidence from high-yield bonds

This paper provides primary evidence of whether certification via reputable underwriters is beneficial to investors in the corporate bond market. We focus on the high-yield bond market in which certification of issuer quality is most valuable to investors owing to low liquidity and issuing firms’ high opacity and default risk. We find bonds underwritten by the most reputable underwriters to be associated with significantly higher downgrade and default risk. Investors seem to be aware of this relation, as we further find the private information conveyed via the issuer-reputable underwriter match to have a significantly positive effect on at-issue yield spreads. Our results are consistent with the market-power hypothesis, and contradict the traditional certification hypothesis and underlying reputation mechanism.

Is There Value in Valuation?

It seems self-evident to many investors that valuation is the key to picking winners in a sector-rotation strategy. The authors’ analysis of quality tiers within the high-yield bond market casts doubt on that premise. The market’s direction exerts such a big influence on relative returns that limited room remains for valuation to have an impact. In light of the authors’ findings in the speculative-grade debt market, value-oriented investors in other asset categories may also need to rethink their assumptions. <b>TOPICS:</b>Fundamental equity analysis, in markets, information providers/credit ratings

Aggregate Earnings and Corporate Bond Markets

I examine the previously unexplored relation between aggregate earnings changes and corporate bond market returns. I find that aggregate earnings changes have a negative relation to investment-grade corporate bond market returns and a positive relation to high-yield corporate bond market returns. The aggregate earnings-returns relation is lower (i.e., less positive or more negative) for bonds with higher credit ratings and longer maturities. Further, I show that the aggregate earnings-returns relation is driven by both the expected and the news component of aggregate earnings changes. The expected component is negatively related to expected returns, and the news component is positively related to cash flow news and changes in nominal interest rates, and negatively related to changes in default premia. My results contribute to the understanding of the role of earnings in corporate bond markets as well as the macroeconomic role of accounting information.

Underwriter Reputation and the Quality of Certification: Evidence from High-Yield Bonds

This paper provides primary evidence of whether certification via reputable underwriters is beneficial to investors in the corporate bond market. We focus on the high-yield bond market, in which certification of issuer quality is most valuable to investors owing to low liquidity and issuing firms’ high opacity and default risk. We find bonds underwritten by the most reputable underwriters to be associated with significantly higher downgrade and default risk. Investors seem to be aware of this relation, as we further find the private information conveyed via the issuer-reputable underwriter match to have a significantly positive effect on at-issue yield spreads. Our results are consistent with the market-power hypothesis, and contradict the traditional certification hypothesis and underlying reputation mechanism.

Ankündigungseffekte der Emission von High-Yield Bonds in Europa

Ankündigungseffekte der Emission von High-Yield Bonds in Europa Diese Arbeit untersucht für den noch jungen europäischen Corporate-High-Yield-Bond-Markt, wie sich die Ankündigung einer Anleiheemission auf den Aktienkurs der emittierenden Unternehmen auswirkt und welche Determinanten einen Erklärungsgehalt für die beobachtete Aktienkursreaktion liefern können. Anhand aller identifizierbaren Ereignisse im Zeitraum 1998 bis 2006 findet diese Studie eine signifikante, negative kumulierte abnormale Rendite von -1,14% in den drei Tagen um den Ankündigungstag. Wie bisherige US-Studien (u. a. Huffman/Ward (1996)) kann auch diese Studie keine Determinanten für die Höhe der abnormalen Renditen identifizieren. (JEL G32)

An analysis of credit risk spreads for high yield bonds

The overall growth and volatility in the high yield (HY) bond market has provided a viable source of capital and an interesting investment asset class. The result has been strong interest in the HY bond credit risk spread (CRS) because this series is very volatile and has a significant impact on the availability of capital to issuers and the rates of return and risk results for investors. Given these trends in the HY bond market, our study has two purposes. The first is to examine statistical properties of the CRS series for the aggregate HY bond market and the three rated components. The second purpose is to interpret the influence that a set of variables are expected to have on future CRSs and, therefore, HY bond performance. In summary, the statistical analysis indicates a significant business cycle effect, but does not show a monetary policy impact. Additionally, the study finds significant differences in characteristics among bonds with alternative ratings. The analysis of specific variables highlights the strong influence of direct and indirect measures of default risk, capital market risk factors, a specific measure of monetary policy, and an impact from liquidity within the HY bond market. There was also evidence of segmentation within the HY bond market because the empirical results indicate that we should consider separate models across rating classes that employed different variables as well as coefficients that were significantly different for the same variables.

Corporate Credit: Defaults, Recoveries, and Ramifications

The short-term success of a high-yield bond strategy hinges on the default and recovery rates that materialize. The average of four different default rate prediction models indicates that the 2009 default rate may be the highest in history. Experience shows that high default rates are associated with low recovery rates—the ultimate concern of high-yield bond investors—also known as the loss given default. Although the combination of forecasted high default rates and low recovery rates is not good news for high-yield bond investors in 2009, being prepared may allow investors to better protect their portfolios from already tumultuous markets. Despite record default losses expected in 2009, the high-yield bond market could perform well in 2009 if the general economic picture improves.