Tables have turned for high yield

This is part one of a two-part look at the current environment for credit markets.

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Capital markets have seen a tremendous amount of volatility over the past 18 months, with credit markets in general and equity markets all bottoming out around the same time in mid-February.

But here’s the good news: “Since then, the high-yield market has posted one of [its] strongest gains since 2009, which was when it recovered from the depths of the financial crisis”—as of early August, total return was up 18% from the bottom in mid-February, says Nicholas Leach, vice-president of global fixed income at CIBC Asset Management, and the lead manager of the Renaissance High-Yield Bond Fund.

Read: Don’t underestimate high yield

This recovery is actually the mirror image of the negative returns in 2015, he adds. “Energy and materials were the two sectors that led the market down in 2015, and now they’re leading this year’s recovery. If we look at the year-to-date market returns, as of the first week of August, high-yield as a whole was up 12%. If you look within that, the energy sector was up 26%, and metals and mining was up 32%.”

Read: Value stocks beating growth stocks

However, there’s also a big divergence in terms of quality, warns Leach. In the summer, “we had the stronger BBs that were up 9%, [while] the lower-quality CCCs were up 21%.”

Investment strategy

“In terms of our positioning, we have been underweight energy and overweight basic materials, and those two weights have really offset one another,” says Leach. “We’ve also had a slight overweight in telecom.”

Read: Benefits of flexible yield strategies

Even though the energy sector has performed well, Leach remains conservative. “If you look at some of the higher-beta sectors such as energy, I would describe our exposure within this sector as very conservative.” As of early August, his fund had a 10% weight in energy, but half that weight was in downstream and midstream companies.

Says Leach, “If we think about companies such as pipeline companies, and distribution, storage and even retail gas stations, these types of companies are relevant businesses. While they are included in the energy sector, they’re not very sensitive to commodity prices. Our positioning is really helping performance in 2016 and, in fact, we’ve made up all of the lost ground that we’ve seen in 2015.”

Read: Oil: $60 is the new $90

Whether markets are up or down, he notes, it’s important to maintain “a consistent and analytical strategy and approach. You can’t fall into emotional traps, or let fear and greed drive decisions. We base our investment decisions on the relative value between intrinsic and market credit spreads, and we held onto many of our companies at the bottom and even topped up at the bottom of the market.”

One thing you can do when markets are jumpy, says Leach, is look for “opportunities to upgrade the credit qualities of portfolios.” Even though he’s still holding companies that he purchased at the bottom of the cycle, he’s also “moving up in the capital structure by, for example, swapping out of a company’s unsecured bonds into [its] secured bonds.”

Read: The hidden risk in corporate balance sheets