Fixed-Income Insights

High yield credit is now a global asset class, offering investment opportunity in markets outside the United States. We believe Lord Abbett’s time-tested, high yield investment philosophy can serve as a driver of potential outperformance for global high yield investors.

 

In Brief

  • Our analysis shows that a lack of bias, either by ratings, sector, or geography, may create opportunity for potential outperformance versus benchmarks.
  • Looking specifically to quality, we find that an unconstrained global high yield strategy has favorably outperformed both ‘BB’-credit rated and ‘B’-rated portfolios (BB/B) over the trailing three- and five-year periods ended 31 December, 2019.
  • Rotation opportunities exist across geographies, and the correlation of returns across the United States, Europe, and emerging markets (EM) breaks down when macro challenges emerge that are specific to regions.

 

We subscribe to the view that an interconnected world has rapidly moved toward the globalisation and democratisation of financial markets alike. Among other implications, this suggests that a flexible and unbiased approach to portfolio management across geographies, credit quality, and sectors should have some appeal to investors. Additionally, as high yield credit investors since 1971, Lord Abbett has consistently maintained that the primary drivers of performance in any high yield portfolio should come from the combination of an informed view of macroeconomic and technical factors as well as in-depth, fundamental credit research. With this backdrop, we explore the global high yield market opportunity today. We believe the Lord Abbett Global High Yield Fund is well-positioned to implement our historically successful approach to US high-yield investing across a global opportunity set and to offer global investors the potential for attractive risk-adjusted returns.

The Starting Block to Global High Yield Portfolio Management
We believe one powerful result of combining the above-noted approaches is that our investment strategy is scalable both within and across asset classes, allowing us to potentially extend our historical investment success in the US high yield market to the broader global high yield market. In fact, a hallmark of our investment process has been this flexibility. Over the past decade, our flagship high yield strategy has had significant exposure to non-US domiciled high-yield issues, albeit primarily in US dollar-denominated bonds, averaging approximately 19% of the portfolio (in the 10-year period ended 31 December, 2019) and ranging from as high as 29% to as low as 7%. We believe this experience illustrates both our credit analysts’ ability to uncover potential value globally and our portfolio managers’ flexibility to rotate as the macroeconomic environment dictates.

We start by simply noting that the size of the global high yield market (as measured by the ICE BofAML Global High Yield Index) has more than doubled over the last 10 years to nearly $2.1 trillion (as of 31 December, 2019). Further, over 60% of this growth has come from outside the United States. Given the evolution of the sub-investment-grade corporate bond market, how should a global high yield portfolio manager proceed? It comes down to three decision levers in our view, summarizing a process we have similarly employed successfully in our US high yield strategies:

  1. Deciding on the overall level of portfolio risk based on an assessment of the broader macro and technical environment;
  2. Identifying where on the credit curve, and in which regions and industries, we want to deploy capital; and then
  3. Executing individual security selection informed by the themes and broader opportunities identified through the assessment of what are likely to be the key drivers of credit spreads going forward.

So why marry this framework with an unbiased approach? As Chart 1 shows, even within the same economic cycle, there have been wide disparities in returns across credit ratings and sectors.  Maintaining a bias either by credit quality or by limiting the pool of sectors within just this cycle would have served intermittently as a significant drag on returns. Conversely, identifying those segments of the market that outperformed and maintaining meaningful active weights in these areas may drive compelling performance, all things being equal. We believe an unbiased approach would better position a skilled, flexible, and tactical manager to capture these yearly variations through a top-down directed view, better allocating credit research resources. Yes, a well-resourced credit research function is at the core of our firm. But we believe relying solely on credit and security selection with an otherwise static quality, sector, and/or geographic weighting within global high yield would risk missing the forest through the trees.

 

Chart 1. A Typically Wide Gap between Best and Worst Returns across Global High Yield Industry and Ratings Cohorts Suggests a Top-Down Approach Matters
% Total returns by sector (top chart) and credit rating (lower chart) (31 December, 2012–31 December, 2019)

Source: ICE Data Indices, LLC (ICE BofAML Global High Yield Index). The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indices are unmanaged, do not reflect the deduction of fees or expenses, are not available for direct investment. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

The Global High Yield Market Today
Before we delve further into the potential performance drivers across global high yield, Table 1 provides a brief snapshot of the opportunity set. For example, the market value of emerging market (EM) high yield now eclipses that of Europe. Meanwhile Europe is a notch better than both the US and EM markets on a composite ratings basis. Finally, average issue size and duration is comparable across all three regions, but EM has benefitted from the lowest dollar price at the overall index level.

 

Table 1. Comparing Regional High Yield Markets

Source: ICE Data Indices, LLC (ICE BofAML US High Yield Index, ICE BofAML High Yield US Emerging Markets Liquid Corporate Plus Index, ICE BofAML European Currency High Yield Index). The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results. Indices are unmanaged, do not reflect the deduction of fees or expenses, are not available for direct investment. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

Lack of Bias by Credit Quality
Despite the outperformance of higher quality high yield in 2019 (specifically in the United States), the allure of “up in quality” BB/B mandates is not matched by outperformance over high yield mandates that embrace an unbiased approach over the longer term. We first examined this reality in our 2018 publication,“Taking the Bias Out of Your High-Yield Portfolio,"  then with a particular focus on the US high yield market. Here, we extend that analysis to the broader global high yield market.

In particular, in Chart 2 we show the rolling five-year performance differential between the ICE BofAML Global High Yield Index and the ICE BofAML BB-B Global High Yield Index. Observations above the line indicate outperformance of the broad high yield index most of the time. Indeed, with the exception of the three shorter periods around the 2008 recession, the 2015-2016 pullback related to the commodity market, and 2019, the broader market opportunity has outperformed a ratings biased approach. Further, examining all the rolling five-year periods since the indices’ inceptions, we find that broad global high yield outperformed the BB/B index 79% of the time, with a maximum outperformance of 2.4% and a maximum underperformance of just less than 1% (see Table 2).

 

Chart 2: Historically, the Broad Global High Yield Index Has Outperformed the BB/B Index Most of the Time
Rolling 5-year Index Performance Comparison (31 December, 2004–31 December, 2019)

Source: ICE Data Indices, LLC (ICE BofAML Global High Yield Index and ICE BofAML BB-B Global High Yield Index). The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indices are unmanaged, do not reflect the deduction of fees or expenses, are not available for direct investment. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

The Rationale for Having a Product That Can Be Tactical Among Regions
While we believe stand-alone geographic high yield credit allocations can have a role to play in a well-diversified portfolio, we also believe that alpha can be better generated by a manager having a geographically unconstrained and flexible approach to allocate finite resources. Part of the challenge of an expanded opportunity set across the globe is having a view on which markets, which sectors, and which securities to own and when. Through a global credit cycle, different markets will offer differing levels of opportunity (and risk) and therefore at different times may deserve varying levels of exposure as we showed above. In line with our opening comments, we believe the best approach is to start with a portfolio-level decision regarding overall risk stance, followed by decisions at the market and sector levels, and then best implemented at the single-security level.

As we see in Chart 3, while EM, US and European high yield market spreads have generally moved together over time, there have been periods where the performance has diverged. For example, the intensification of the European sovereign debt crisis in 2011 saw regional spreads materially underperform those of the United States. EM spreads widened materially in late 2014 as corruption in Brazil and the continued Russian intervention in Ukraine weighed materially on EM investor sentiment. However, the move lower in commodities over 2015 and 2016 affected the US market more heavily, with state-owned energy entities in EMs faring better than US leveraged shale plays. And finally, a strengthening US dollar, ramping trade tensions, and related EM mutual fund outflows in early 2018 again pressured EM long before the rollover of the US market in fourth quarter 2018.

 

Chart 3: There Were Similar Spread Moves in Regional Markets over Time, but Opportunity to Rotate as Well
Spreads (basis points) (30 June, 2010-30 September, 2019)

Source: ICE Data Indices, LLC (ICE BofAML US High Yield Index, ICE BofAML High Yield US Emerging Markets Liquid Corporate Plus Index, ICE BofAML European Currency High Yield Index). The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indices are unmanaged, do not reflect the deduction of fees or expenses, are not available for direct investment. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

Displayed another way, in Chart 4 we see that return correlations can break down at points in time between different markets. While these charts are busy—that’s also the point. Correlation of returns across markets can vary, and as a result, having a flexible approach to tactically rotate among these regional high yield markets allows for greater alpha potential in our view.

 

Chart 4. …And Viewed Another Way, Correlations of Returns Are Volatile Themselves
Total return correlation (30 June, 2010-30 September, 2019)

Note: Correlation measured by trailing 63 trading day (approximately 3 months) correlation between respective markets’ total return indices
Source: ICE Data Indices, LLC (ICE BofAML US High Yield Index, ICE BofAML High Yield US Emerging Markets Liquid Corporate Plus Index, ICE BofAML European Currency High Yield Index). The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indices are unmanaged, do not reflect the deduction of fees or expenses, are not available for direct investment. Investors may experience different results.
Past performance is not a reliable indicator or guarantee of future results.

 

Moving away from index data to real-world application, the removal of bias from high yield investing, whether anchored in credit quality, geography, or industry, has permitted the Lord Abbett Global High Yield Fund to consistently outperform historically not only its peer group, as measured by the Morningstar EAA Global High Yield Fund category, but also the Fund’s benchmark index and the up-in-quality version of the global high yield index—both of which are not investable. Lord Abbett’s Global High Yield Fund also handily outperformed the investable passive global high yield alternative, the HYLD ETF.

 

Table 2. Demonstrated Historical Capability across the Global High Yield and U.S. High Yield Markets

The total expense ratio is 0.80% for the Global High Yield Fund Class I (DIS) USD Shares and 0.75% for the U.S. High Yield Fund Class I (ACC) USD Shares. The Total Expense Ratios in the table represent the net expense ratio of each fund, which takes into account a management fee waiver whereby Lord Abbett has agreed to waive a portion of its management fee. Lord Abbett may stop the management fee waiver at its discretion. For periods when the waiver is in place, the Funds may benefit by not bearing these expenses. Without such management fee waiver, performance will be lower. Please see each Fund's prospectus for additional information.
Performance data quoted reflect past performance and are no guarantee of future results. Current performance may be higher or lower than the performance quoted. The net asset value performance above shows each Fund's average annual total returns excluding sales charges, which are not applicable to Class I shares. If sales charges had been included, performance would have been lower. The investment return and principal value of an investment in either fund will fluctuate so that shares, on any given day or when redeemed, may be worth more or less than their original cost.
*Source: Morningstar, Inc. Morningstar® Funds Category rankings reflect all share classes within the category and are based on total return, including the reinvestment of all distributions, and do not reflect the effect of sales charges.

 

Chart 5. Our Active, Flexible and Unconstrained Approach Has Led to Outperformance Historically in Global High Yield
Hypothetical investment (US dollar) (30 October, 2016–31 December, 2019)


Source: ICE Data Indices, LLC (ICE BofAML Global High Yield Index, ICE BofAML BB-B Global High Yield Constrained Index) and Morningstar®, Inc. Based on a hypothetical Class I (DIS) USD investment of $100 on 30 October, 2016 without sales charges and includes the reinvestment of all distributions. The index and ETF data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indices are unmanaged, do not reflect the deduction of fees or expenses, are not available for direct investment. Investors may experience different results. The Morningstar® category performance is based on the category average which reflects all share classes within the category and are based on total return, including the reinvestment of all distributions, and do not reflect the effect of sales charges.

 

So, what explains this consistent outperformance historically? We think there are a few key differentiators that contribute to how we have successfully extended our approach to US high yield investing into the global opportunity set, especially as it pertains to protecting investor capital in volatile market environments. These include:

  • A continuous focus on what we believe will drive credit market performance. This top-down approach allows us to potentially capture regional and sector themes that can be significant causes of performance dispersion in the markets. Managers who focus solely on a bottom-up approach may miss the bigger trends that define market opportunity.
  • Flexibility to participate, but with risk limits on lower-tier credits. Part of the allure of ‘BB’-/‘B’- rated mandates for some investors is that many high yield managers have not done a great job navigating the ‘CCC’-rated space. We have rigid position-sizing guidelines for ‘CCC’-rated credits that help us to mitigate idiosyncratic risk in volatile credit environments.
  • Experience. We have almost 50 years of experience as a firm honing our craft in the leveraged-credit markets, along with a deep bench of experienced portfolio management and credit analyst teams.


The authors wish to gratefully acknowledge the assistance of Katie Cheung, Associate Director in Digital Services, for her contribution to this report.

 

Important Information

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. No investing strategy can overcome all market volatility or guarantee future results. Investing in international denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. The securities markets of emerging countries tend to be less liquid, especially subject to greater price volatility, have a smaller market capitalization, have less government regulation and may not be subject to as extensive and frequent accounting, financial and other reporting requirements as securities issued in more developed countries.

Glossary of Terms

 Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index or benchmark that is considered to represent the market's movement as a whole. The excess return of an investment relative to the return of a benchmark index is the investment's alpha.

A basis point (bp) is one hundredth of one percent.

 A coupon payment on a bond is the annual interest payment that the bondholder receives from the bond's issue date until it matures. Coupons are normally described in terms of the coupon rate, which is calculated by adding the sum of coupons paid per year and dividing it by the bond's face value.

Correlation is a statistic that measures the degree to which two securities move in relation to each other.

credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality. 

Duration is an approximate measure of a bond's price sensitivity to changes in interest rates.

Modified duration to worst is a measure of the sensitivity of the price of a bond to a change in interest rates, assuming the worst-case scenario—in this case, that the bond is called at its earliest possible call date.

An option-adjusted spread (OAS) converts the difference between the fair price and the market price of a fixed income security, typically a bond or a mortgage-backed security (MBS), into yield and calculates a spread that makes the two prices equal.

Par weighted price indicates whether the fund favors bonds selling at prices above or below face value (premium or discount securities, respectively) and can also serve as an indicator of interest-rate sensitivity. This statistic is expressed as a percentage of par (face) value.

The ICE BofAML Global High Yield Index tracks the performance of USD, CAD, GBP and EUR denominated below investment grade corporate debt publicly issued in the major domestic or Eurobond markets.

The ICE BofAML Global High Yield BB-B Index is a subset of the ICE BofAML Global High Yield Index, including all securities rated BB-B or lower.

The ICE BofAML CCC & Lower Global High Yield Index is a subset of the ICE BofA ML Global. High Yield Index, including all securities rated CCC1 or lower.

ICE BofAML US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.

ICE BofAML High Yield US Emerging Markets Liquid Corporate Plus Index tracks the performance of U.S. dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

ICE BofAML European Currency High Yield Index is designed to track the performance of euro- and British pound sterling-denominated below investment grade corporate debt publicly issued in the eurobond, sterling domestic or euro domestic markets by issuers around the world.

Source ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN “AS IS” BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD ABBETT, OR ANY OF ITS PRODUCTS OR SERVICES.

Indices are unmanaged, do not reflect the deduction or expenses, and are not available for direct investment.

The credit quality of the securities in a portfolio are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principle on these securities.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based

on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information.

The Lord Abbett Global High Yield Fund and High Yield Fund are sub-funds of Lord Abbett Passport Portfolios plc, an open-ended investment company with variable capital constituted as an umbrella fund with segregated liability between its sub-funds under the laws of Ireland (registered number 534227), and is authorized and regulated by the Central Bank of Ireland as an Undertaking for Collective Investments in Transferable Securities ("UCITS"). Authorization of the Lord Abbett Passport Portfolios plc by the Central Bank of Ireland is not an endorsement or guarantee nor is the Central Bank of Ireland responsible for the contents of any marketing material or the Fund's prospectus. Authorization by the Central Bank of Ireland shall not constitute a warranty as to the performance of the Lord Abbett Passport Portfolios plc and the Central Bank of Ireland shall not be liable for the performance of the Lord Abbett Passport Portfolios plc.

Shares of the Funds are only available for certain non-U.S. persons in select transactions outside the United States, or, in limited circumstances, otherwise in transactions which are exempt in reliance on Regulation S from the registration requirements of the United States Securities Act of 1933, as amended and such other laws as may be applicable. This document does not constitute an offer to subscribe for shares in the Fund. This document should not be provided to retail investors in the United States. In the United States, this document is directed at professional/sophisticated investors and is for their use and information. The offering or sale of Fund shares may be restricted in certain jurisdictions. For information regarding jurisdictions in which the Funds are registered or passported, please contact your Lord Abbett sales representative. Fund shares may be sold on a private placement basis depending on the jurisdiction. This document should not be used or distributed in any jurisdiction, other than those in which the Funds are authorized, where authorization for distribution is required. Lord Abbett Distributor LLC ("LAD") is authorized by the Fund to facilitate the distribution of shares in certain jurisdictions through dealers, referral agents, sub-distributors and other financial intermediaries. Any entity forwarding this material, which is produced by LAD in the United States, to other parties takes full responsibility for ensuring compliance with applicable securities laws in connection with its distribution.

Note to European Union Investors: This communication is based in the United Kingdom and distributed throughout the European Union by Lord Abbett UK Ltd., a Private Limited Company registered in England and Wales under company number 10804287 with its registered office at 1 Fetter Lane, London, United Kingdom, EC4A 1BR. Lord Abbett UK Ltd. (FRN 783356) is an Appointed Representative of Duff & Phelps Securities Ltd. (FRN 466588) which is authorized and regulated by the Financial Conduct Authority.

Passport Portfolios

Global High Yield Fund

ABOUT THE AUTHORS