The recent bounce in equity markets hints that risk appetite could be returning as investors position for Q2. US high yield bonds may offer an area of opportunity. And while an ESG exposure may not seem like the obvious approach, given high energy prices and the prospect of greater defence spending, the Bloomberg SASB US Corporate High Yield ESG Ex-Controversies Select Index has actually outperformed its parent index in 2022.
The first quarter of 2022 has been a tough one for fixed income investors. As fears over inflation have continued to grow, exacerbated by the Russian invasion of Ukraine and the spike in commodity prices, central bank rhetoric has turned more hawkish and policy has been tightened.
The US 10-year yield has soared close to 100bp since the start of the year, with the 65bp rise seen so far in March marking the biggest monthly move since April 2004.1 With over 200bp of further Federal Reserve (Fed) rate rises now priced by the market and 10-year break-evens back at their historic wides, there may be a sense that the bond market has priced in a significant amount of policy tightening and inflation.
Credit strategies have provided little in the way of protection. In addition to a rise in the risk-free rate, higher energy prices and fears that the Fed could over-tighten policy have eroded growth expectations, resulting in a blow-out in credit spreads.
The bounce in equity markets hints that risk appetite may be returning as investors position for Q2 and, given the magnitude of the sell-off, there could be some interest to return to strategies such as US high yield. We see four important reasons to consider this area of fixed income.
In the current environment, with high energy prices and the invasion of the Ukraine boosting defence spending, it may seem counterintuitive to focus on an ESG strategy. While the Bloomberg SASB US Corporate High Yield ESG Ex-Controversies Select Index does screen for weapons manufacturers and distributors as well as companies involved in thermal coal, oil sands and arctic oil and gas, it also optimises the index in order to push its characteristics toward those of the parent index.
This process of creating a core bond holding with higher ESG-scoring bonds has actually resulted in the index delivering a stronger performance so far in 2022 compared with the parent index.3 A performance attribution of the Bloomberg SASB US Corporate High Yield ESG Ex-Controversies Select Index versus the parent Bloomberg US Corporate High Yield Index for 2022 suggests two areas have driven this outperformance: energy and communications.
The USD is usually a key beneficiary of any risk-off market move. In the case of the Russian invasion of Ukraine, an additional impetus for a move lower in EURUSD came from the fact that the US is less impacted by this geopolitical risk than Europe. This USD strength will have enhanced returns on USD-denominated assets for EUR-based investors but could now represent a risk to future returns if the USD starts to weaken.
Currency hedging provides an option for reducing this risk. The rise in USD relative to EUR rates has made hedging more expensive but the strategy employed by State Street Global Advisors is to hedge exposure on a monthly basis to align with the monthly index rebalancing. The 1-month forward EURUSD hedge costs 10.5bp, which equates to just under 130bp on an annual basis. This would still imply a yield to worst of around 4.7% for the Bloomberg SASB US Corporate High Yield ESG Ex-Controversies Select Index.
Investors looking to access the high yield ESG theme can do so with SPDR ETFs. To learn more about these ETFs, and to view full performance histories, please click on the links below to visit their fund pages.
SPDR Bloomberg SASB U.S. High Yield Corporate ESG UCITS ETF
SPDR Bloomberg SASB U.S. High Yield Corporate ESG EUR Hdg UCITS ETF
1 Bloomberg Finance L.P., as of 24 March 2022.
2 The Bloomberg US Corporate High Yield Index has returned -5.68% for 2022 Year-to-date against --6.36% for the Bloomberg US Treasury Index and -9.04% for the Bloomberg US Corporate Index. As of 25 March 2022.
3 The Bloomberg SASB US Corp HY ESG Ex-Controversies index has returned -5.09% for 2022 versus -5.68% for the parent Bloomberg US Corporate High Yield Index. As of 25 March 2022.
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For Investors in Austria: The offering of SPDR ETFs by the Company has been notified to the Financial Markets Authority (FMA) in accordance with section 139 of the Austrian Investment Funds Act. Prospective investors may obtain the current sales Prospectus, the articles of incorporation, the KIID as well as the latest annual and semi-annual report free of charge from State Street Global Advisors Europe Limited, Branch in Germany, Brienner Strasse 59, D-80333 Munich. T: +49 (0)89-55878-400.F: +49 (0)89-55878-440.
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