The Importance of Sector Risk in Comparing High Yield and Leveraged Loans

How do sector risk and liquidity in today’s fixed income markets compare to five years ago? Brean Capital’s Peter Tchir joins S&P DJI’s J.R. Rieger and Shaun Wurzbach to discuss index-based strategies in the current fixed income landscape.

How to risk and liquidity in today’s fixed income markets compared to five years ago hello i’m paul murdoch and joining me today to discuss duration risk and liquidity and senior loans and high-yield corporates are peter cheer managing director at breen capital junior rieger head of fixed income indices at sp dji and shawn wars boc who leads snp dj eyes financial

Advisor channel management team gentlemen thanks for being here today thank you thanks a lot it’s good to be back so junior can you start us off with giving us an overview of duration risk in senior loans and high-yield corporates first when we compare the two asset classes paulonez a floating rate asset class of senior loans it is that floating rate as a class

Versus fixed rate high-yield corporate bonds and the duration when you measure a floating rate is based on when they reset so they’re relatively short it can be measured in weeks there’s different methodologies there but it’s very very short from a duration measurement perspective versus the spus high-yield corporate bond index which has an effective duration

Of about four and a half years so very different duration risk profiles between a two asset classes well how does the default and recovery risk data compared to the past five years again two different asset classes measuring really the junk side of the market but senior loans are secured where high-yield debt is unsecured corporate bond debt and the recovery

Rates are significantly different the senior loans typically have a recovery rate somewhere between 80 and 90 percent of par versus a recovery rate that’s significantly lower of about 40 cents on the dollar for for us unsecured credit great thanks june so peter let’s let’s move on to liquidity how does liquidity look like in the space i would say if i look at

The beta product so etfs would be included in that index based products the liquid ii is pretty good because people can trade in and out and you’re really trading as an asset class rather than individual credits i think as you move towards individual bonz liquidity is less good it tends to be very one directional which by which i mean there’s everyone trying to

Buy the bond or everyone trying to sell the bond at the same time so i like you know the beta products the one thing to within this liquidity that i always want to highlight is credit and fixed income tends to look like this and then drop and that’s always the concern so we’ve had this very long run so i think we want to be cautious and be aware that liquidity

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Particularly that a downside tends to be lower okay so you mentioned etfs then how how might investors use etfs to help them i think they’re a very powerful product you know i heard a lot a couple years ago people talking about the great rotation out of fixed income back into stocks to me people have been under allocated fixed income for so long they just weren’t

Managing it right so this gives people the real tool to be do i want to be a municipal bonds do i want short duration long duration do i want more credit exposure less credit exposure so i think it’s a great tool to be able to manage your risk and express your views and your thoughts on where the economy’s headed and get the best risk reward profile out of that

Great thanks peter so sean we have a range of index data available for investors to use yeah looking specifically at senior loans and high-yield corporates how might they use this analysis in their decisions it’s a great question because i totally agree with where pete is going with this if you look at how indices have been transformed into etfs roll o’clock ten

Years back and advisers didn’t have access to beta versions of high-yield or beta versions of leveraged loans so now they have different tools for different jobs using those index based approaches for leverage loan and high-yield and again as you know we’re out there working with advisers and helping to use the the indices or analytics to educate them and we can

Show them that it’s not just about looking it’s similar but different yields you have to look at these as jr said as very separate asset classes with completely different construction and completely different risk so are there any shifts that you’re observing that are influencing the decisions that advisors are making what are you hearing on the road well i think

That that one concern i would have or if shift is that that democratization isn’t always necessarily a good thing it’s given them access to high yield and in doing so that’s generally a diversified beta based basket it’s you know it’s a broad benchmark type index and i think that some advisors feel that ok i’ve i’ve mitigated that risk that i could have a single

Ball a bond default risk and somehow they’ve made the leap to think that well now my risk is is only that there could be some kind of recession within the entire economy you know i’m so broadly diversified and i’m you know if that’s my risk i can hear that coming like who can’t see a recession coming but instead i love this discussion on on sector based risk

Because i do believe that that’s the risk that they’re not fully appreciating and that could really impact a risky asset class like high yield and within the world of high yield you have consumer discretionary last night we heard jc penney didn’t make the numbers the night before i was macy’s a couple days before that it was sears and then it was walmart before

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That it just kind of a drumbeat of alarm within a certain part of the high-yield segments and the other thing i think people have to be aware of if they’re in the high yields one of things that really drove the energy was the threat of downgrade to the investment grade companies flooding the high-yield market you’ve got some other areas whether it’s telecom where

You have these big huge debt issuers we’re all triple b issuers who their businesses may be floundering they could be fine but so there’s risk too high yield very sector-specific and if you get some down grades coming from the other direction you could see problems so timing is always one of those concerns what are you seeing in the unconstrained bond management

Space in particular i think they’re you’re seeing a little bit of a move toward safety you’re seeing inflows into a lot of the leverage loan type product you see continued inflows into the investment grade bonds you’re seeing a little bit of outflows out of the high-yield and that i think is rational people are saying hey this is where we are in terms of credit

Spread and yields i want to be a little bit cautious i want to keep some money on the sidelines so if there is a dip we can have that money to put to work so given everything that’s going on i want to i can get your views then is this perhaps a moment when active managers can outperform passive i think this is a really critical year for active managers that they

Know they have to beat the benchmarks they really have to help perform passive strategies and with yields relatively low spreads relatively low they have that real opportunity so i think they will be able to do it i think it’s critical they do it or else they will will see continued outflows from active into passive pete’s comments resonate with me in particular as

A high-yield guy for many years but the issues i see is that we all we all know that the buy-side has the best portfolio managers the best analysts the best traders the best access the data the best systems but historically they have not outperformed rules-based indices and then that is something that we need to watch going as we go further into 2017 and if they

Do outperform the benchmark index in 2017 can they do it again in 2018 will there be that persistence of performance if you will and then you always have the question of if you’re an investor how are you choosing your manager now you’ve had some outperform you’ve had some not perform as well as an index and will that it that index manager that that fund manager

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That outperform this year will they do it again next year so all these questions are right here in the us corporate bond market definitely yeah well we could put some data on that too so we have our speaker report and i think in the advisor community we’ve done a fantastic job of educating them about how effective equity indices are using speed data and the last

Speed report had 15 years worth of data less well known is that there’s a report within speevak that covers fixed income so let’s let’s talk about some of those numbers one year 94.1 7% of the mutual funds that track a high yield mandate were outperformed by barclays corporate high yield so a little bit more than 5% of the mutual funds outperform the index it

Varies a little bit it goes as low as 88% the 15-year mark 95.9 2% of those mutual funds were out performed by the benchmark so indices can be effective beta within fixed income it’s a little bit different you know not nearly as stark within the leverage loan space there we only have five years so last year eighty one point eight two percent of mutual funds that

We’re tracking a leveraged loan type mandate were out performed by the leveraged loan 100 our index there but it’s it’s not always been the case in the three years it was forty five point ten percent so the majority of active managers in the three-year mark outperform that index and i think that what advisers need to do is they need to look past whether it’s

Active or passive and they need to look deeper if they’re going to look at active management they need to look at what’s the active manager trying to do and if they’re concerned about the asset class and they want risk management and the active manager is going to deliver that that would be a consistent way to think through it i think what our research shows is

There’s also room for very effective beta and that’s what these indices provide well guys thanks so much for your views today valuable insight as you thanks rather and we’ll be checking back in with the biannual stiva data to see who’s right and the persistent scorecard as well for more information on how indexing works for advisors and to access a wide range of

Fixed income index data and to see the semi-annual spiga reports visit us at sp dji comm thank you you you

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The Importance of Sector Risk in Comparing High Yield and Leveraged Loans By S\u0026P Dow Jones Indices Channel