SPDR® Blackstone High Income ETF (HYBL) - Q2 2022 Commentary
Since its inception, HYBL has outperformed its Morningstar high yield mutual fund peers by an average of 188 basis points (bps).1Since its inception, HYBL has outperformed its Morningstar high yield mutual fund peers by an average of 188 basis points (bps).1
Performance Summary Comment
Loans outperformed high yield bonds in the second quarter of 2022. HYBL returned -7.69%, underperforming the Blended: 50 S&P/LSTA U.S. All Loans + 50 ICE BofA US HY Constrained Index by 47 bps.2
HYBL underperformed its benchmarks in the second quarter due to its performance in the month of June which was driven by its credit selection within high yield and loans. HYBL de-risked and diversified its loan allocation during the quarter, reducing lower-rated exposure while rotating into higher-quality credits. The top contributors to total return in the second quarter were Triumph Group, Inc., UWH PLLC, and Consolidated Communications, Inc. The top detractors were Crown Finance US Inc, Nationstar Mortgage Holdings Inc, and Quest Software US Holdings Inc.
Both loan and high yield bond demand declined during the quarter, with high yield and loans receiving $15.4 billion and $3.1 billion in net outflows, respectively.3 The risk-off sentiment in these asset classes has also impacted the performance of the collateralized loan obligations (CLOs) in the portfolio.
Quarter in Review Commentary
Mounting headwinds weighed on credit markets during the second quarter, as lower growth and recession joined multiple existing concerns. Markets fretted over an increasingly hawkish US Federal Reserve (Fed), which hiked rates twice over the second quarter in an attempt to subdue record-high inflation.4 Interest rate risk morphed into credit risk as investors worried about a policy misstep that might push the economy into recession.
Prices tumbled, issuance dried up, and spreads widened, fueling the up-in-quality rotation out of lower- rated across credit markets. High yield came under the most pressure due to ongoing rate volatility and underperformed other credit markets through the end of the second quarter,5 while CLOs and loans continued to outperform.6
Loan and high yield prices declined to levels last seen during the pandemic. Several sharp selloffs left average loan prices at $92.16 from $97.60 at the end of March,7 while average high yield prices dropped to $85.83 from $97.04 at the start of the quarter.8
Technical and fundamental factors drove the price declines. Loan retail funds flows turned negative over the second quarter, with $3.1 billion exiting loan funds.9 ETFs were large sellers as they sold more liquid loans to cover redemptions. High yield retail funds reported outflows for 20 of the 26 weeks through June 29, taking net outflows to $35 billion for the year. 10
CLO creation ticked up despite widening liability spreads and a lack of primary loans. Managers opted for “print and sprint,” short-dated and static transactions to take advantage of cheap loans. CLO new issuance of $40.2 billion lagged 2Q21 but increased compared to the first quarter’s $30.7 billion.11 CLO AAA spreads widened to an average of 159 basis points over the second quarter, their widest in two years.12
Primary issuance slowed severely, and banks were forced to sell paper at heavy discounts. At $56 billion, institutional loan volume was the lowest since 2Q20,13 while the $24.7 billion of high yield deals was a fifth of the volume recorded in the same period in 2021.14
Relative Value in a Rising Rate Environment
Positioning and Outlook Commentary
HYBL Historical Asset Allocation
The same macro headwinds upsetting markets during the first half of the year are expected to contribute to ongoing volatility over the second half. Monetary policy will also feature as the Fed front-loads its hiking cycle, with another 50-75 basis point hike anticipated in July.15
Credit metrics over the first quarter highlight ongoing fundamental health across leveraged finance companies, but profit margins have dipped due to inflationary pressure. High yield issuers also experienced a contraction in revenues and EBITDA versus the prior quarter for the first time since the second quarter of 2020.16 We subsequently expect investors to monitor second-quarter earnings for signs of any further impact of rising input costs on profit margins.
Defaults are already rising, albeit gradually,17 but we believe the depth of the current selloff is overdone relative to fundamentals. Further, past experience has demonstrated that loan yields at current levels have resulted in compelling returns over the following six to 12 months.
Active management and a responsive asset allocation strategy will be vital, however. And we will continue to evaluate and reposition our portfolios in response to the changing macro backdrop. That means staying up in the capital structure and focusing on defensive sectors with secular growth tailwinds and companies with steady free cash flow generation.
Recovery rates are currently at an average of 67% for leveraged credits, which should offer some comfort against rising defaults.18 Refinancing risk is also negligible over the near term, with just $331 billion of loans and bonds set to mature in 2023/2024. This rises sharply to $1 trillion in 2025/2026.19
Floating-rate assets are already benefiting from higher rates, while in high yield, greater credit spread dispersion resulting from this year’s volatility has created mispricing opportunities. And with high yield spreads in the high 500 basis point area, there is potential for tightening pending any positive macro developments.
We believe that at current levels, loans, high yield bonds, and CLO debt remain highly attractive on a risk-adjusted basis and may produce compelling returns over the next 12 months, when including the forward curve.20 We have already moved in to buy discounted assets and will take advantage of further opportunities, including price volatility, to generate additional alpha for the portfolio.
1 Morningstar Direct, as of June 30, 2022. 2 State Street Global Advisors as of June 30, 2022. 3 S&P/LSTA Leveraged Loan Index, JP Morgan CLOIE, July 1, 2022. 4 Bloomberg News, May 2022. 5 Bloomberg HY Index, July 3, 2022. 6 S&P/LSTA Leveraged Loan Index, JP Morgan CLOIE, July 1, 2022. 7 LCD, S&P/LSTA Leveraged Loan Index, July 1, 2022. 8 Bloomberg HY Index, July 3, 2022. 9 Lipper, LCD, July 1, 2022. 10 Lipper, LCD, July 1, 2022. 11 LCD, Second Quarter Review, July 1, 2022. 12 LCD, Second Quarter Review, July 1, 2022. 13 LCD, Second Quarter Review, July 1, 2022. 14 LCD, Second Quarter Review, July 1, 2022. 15 Blackstone Investment Strategy, June 2022. 16 JP Morgan Research, June 9, 2022. 17 JPM has raised its 2022 and 2023 high-yield bond and leveraged loan default forecasts to 1.25% each in 2022, rising to 1.75% and 2.25% in 2023, respectively, JP Morgan, Default Monitor, June 2, 2022. Citi’s default outlook for the next 12 months remains unchanged for loans at 2.5% and is revised upwards for HY, to 3.3%, Citi, US Leveraged Loans Strategy, June 6, 2022. DB expects US HY defaults to first climb to 5.0% by YE 2023, and peak at 10.3% in 2024 (assuming a recession at the end of 2023 into 2024), DB, 2022: The end of the ultra-low default world? June 6, 2022. 18 CS Credit Strategy Daily, June 21, 2022. 19 J.P. Morgan, July 1, 2022. 20 J.P. Morgan, May 16, 2022.
Basis Point (bps)
A unit of measure for interest rates, investment performance, pricing of investment services and other percentages in finance. One basis point is equal to one-hundredth of 1 percent, or 0.01%.
Bloomberg US Corporate High Yield Index
An unmanaged index that is comprised of issues that meet the following criteria: at least $150 million par value outstanding, maximum credit rating of Ba1 (including defaulted issues) and at least one year to maturity.
Bloomberg US Credit Index
An index that measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets.
Bloomberg US Dollar Floating Rate Note Index
An index that measures the performance of floating rate bonds issued by the US Treasury.
Bloomberg US Treasury Bellwether 3-Month Index
An unmanaged index representing the on-the-run (most recently auctioned) US Treasury bill with 3 months’ maturity.
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