Investing in High Yield Bonds and Bank Loans

High-Yield Bond Market Dynamics

• 2020 Performance: The high-yield asset class saw approximately $45 billion in net inflows, driven by the global search for yield amid historically low or negative interest rates.
• Pandemic Support: Central bank intervention, specifically from the Federal Reserve, facilitated the reopening of capital markets, allowing impacted companies to extend maturities and add liquidity, which resulted in lower-than-expected default rates.
• 2021 Outlook:
  • YTD 2021 has seen roughly $8 billion in outflows attributed to profit-taking and volatility concerns regarding rising rates.
  • Goldman Sachs Asset Management anticipates investor retention and a strong performance year for high yield.
  • Return Forecast: Expected returns are 4–5% for U.S. high yield and 3–4% for European high yield, primarily driven by coupon carry with spreads expected to remain range-bound.
• Quality Migration ("Fallen Angels"):
  • The market absorbed approximately $200 billion in downgrades from investment grade to high yield in 2020, contrary to fears of market saturation.
  • This migration improved overall market quality, with double-B rated credits now comprising roughly 54% of the market.
  • Forward-Looking Trend: The firm anticipates a shift from "fallen angels" to "rising stars" within the next 12 to 24 months, particularly in the energy sector.
• Sector Strategy: The investment team shifted from underweight to neutral/overweight in the energy sector by targeting investment-grade issuers downgraded to high yield, citing their sustainable business models and ability to tap capital markets despite low oil prices.

Bank Loan Asset Class Trends

• Flow Reversal: Following $85 billion in outflows between November 2018 and November 2020 due to low-rate environments compressing floating-rate coupons, the asset class recorded approximately $8 billion in inflows in 2021.
• Investment Drivers:
  • Inflows are driven by anticipated rate hikes, the lack of duration risk, and the asset's position higher in the capital structure (secured by collateral).
  • The Fed's indication that it is "in no hurry" to raise rates has not deterred market expectations of future increases, supporting demand for floating-rate exposure.
  • Bank loans offer attractive yield relative to other public fixed-income classes, including U.S. Treasuries, S&P 500, and investment-grade bonds.
• Demand Composition: Collateralized Loan Obligations (CLOs) now represent roughly 65% of bank loan demand; as "buy-and-hold" investors, they provide price stability and contributed to superior Sharpe ratios over the past decade.
• Return Forecast: Goldman Sachs projects 4.5% to 5.5% returns for bank loans in 2021, derived from carry plus potential price appreciation.

Macroeconomic Outlook and Strategy

• Performance Catalyst: The second half of 2021 is expected to outperform the first half as vaccine distribution accelerates and pent-up consumer demand materializes.
• Active Management Focus: Performance relies heavily on security selection and idiosyncratic risk assessment to navigate varying debt-to-EBITDA ratios and avoid defaults in the high-yield space.
• Risk Context: Leverage ratios for high-yield issuers rose significantly in 2020 due to negative EBITDA; active managers are utilizing this volatility to differentiate between viable survivors and distressed entities.