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.
Yield restored: The yield to worst on the Bloomberg US Corporate High Yield Index is over 6%, its highest since August 2019 (excluding the spike in yields associated with COVID). A part of this is the fact that the spread to Treasuries has pushed back over 330bp, 70bp wider than the tights.
Growth remains firm: A rebound in equity prices hints that market fears over a US recession could be overblown. Indeed, the Bloomberg consensus for US growth this year is still 3.5%, well above the 20-year average of 2%. In addition, the US economy should be less affected than Europe by the impact of the Russian invasion of Ukraine.
Few signs of stress: With most of Q1 completed, there are few signs of financial stress in high yield issuers. The upgrades/downgrades ratios for North America are firmly above 1 for both S&P (1.6) and Moody’s (1.84). As an asset class, high yield fundamentals are in good shape as many companies used 2021 to rebuild the strength of their balance sheets.
Surprisingly defensive: Despite the substantial blowout in credit spreads, performance from a broad high yield index since the start of 2022 has been similar to that of US Treasuries and not as negative as the performance of the all maturity investment grade corporate exposure.2
Figure 1: Upgrades vs. Downgrades for North American High Yield Issuers
ESG: A Road Paved with Good Intentions?
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 Surging USD
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.
How to Play this Theme
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.
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.
Information Classification: General Access.
For professional clients use only.
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.
For Investors in Finland: The offering of funds by the Companies has been notified to the Financial Supervision Authority in accordance with Section 127 of the Act on Common Funds (29.1.1999/48) and by virtue of confirmation from the Financial Supervision Authority the Companies may publicly distribute their Shares in Finland. Certain information and documents that the Companies must publish in Ireland pursuant to applicable Irish law are translated into Finnish and are available for Finnish investors by contacting State Street Custodial Services (Ireland) Limited, 78 Sir John Rogerson’s Quay, Dublin 2, Ireland.
For Investors in France: This document does not constitute an offer or request to purchase shares in the Company. Any subscription for shares shall be made in accordance with the terms and conditions specified in the complete Prospectus, the KIID, the addenda as well as the Company Supplements. These documents are available from the Company centralizing correspondent: State Street Banque S.A., Coeur Défense - Tour A - La Défense 4 33e étage 100, Esplanade du Général de Gaulle 92 931 Paris La Défense cedex France or on the French part of the site ssga.com/etfs. The Company is an undertaking for collective investment in transferable securities (UCITS) governed by Irish law and accredited by the Central Bank of Ireland as a UCITS in accordance with European Regulations. European Directive no. 2014/91/EU dated 23 July 2014 on UCITS, as amended, established common rules pursuant to the cross-border marketing of UCITS with which they duly comply. This common base does not exclude differentiated implementation. This is why a European UCITS can be sold in France even though its activity does not comply with rules identical to those governing the approval of this type of product in France.The offering of these compartments has been notified to the Autorité des Marchés Financiers (AMF) in accordance with article L214-2-2 of the French Monetary and Financial Code.
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Accordingly, the Securities shall only be sold in Israel to an investor of the type listed in the First Schedule to the Israeli Securities Law, 1978, which has confirmed in writing that it falls within one of the categories listed therein (accompanied by external confirmation where this is required under ISA guidelines), that it is aware of the implications of being considered such an investor and consents thereto, and further that the Securities are being purchased for its own account and not for the purpose of re-sale or distribution.
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For Investors in Spain: State Street Global Advisors SPDR ETFs Europe I and II plc have been authorised for public distribution in Spain and are registered with the Spanish Securities Market Commission (Comisión Nacional del Mercado de Valores) under no.1244 and no.1242. Before investing, investors may obtain a copy of the Prospectus and Key Investor Information Documents, the Marketing Memoranda, the fund rules or instruments of incorporation as well as the annual and semi-annual reports of State Street Global Advisors SPDR ETFs Europe I and II plc from Cecabank, S.A. Alcalá 27, 28014 Madrid (Spain) who is the Spanish Representative, Paying Agent and distributor in Spain or at ssga.com/etfs. The authorised Spanish distributor of State Street Global Advisors SPDR ETFs is available on the website of the Securities Market Commission (Comisión Nacional del Mercado de Valores).
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United Kingdom: The Funds have been registered for distribution in the UK pursuant to the UK’s temporary permissions regime under regulation 62 of the Collective Investment Schemes (Amendment etc.) (EU Exit) Regulations 2019. The Funds are directed at 'professional clients' in the UK (as defined in rules made under the Financial Services and Markets Act 2000) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description should not rely on this communication. Many of the protections provided by the UK regulatory system do not apply to the operation of the Funds, and compensation will not be available under the UK Financial Services Compensation Scheme.
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The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
Investing in high yield fixed income securities, otherwise known as "junk bonds", is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
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Informations relatives au Mexique
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