Many investors underestimate the size of the fixed income market. Globally, bonds account for nearly…
What is Australian High Yield?
While hybrid securities are generally Australian investors’ primary choice for high income products, high-yield bond markets constitute a growing alternative. A high-yield bond is typically non-investment grade (i.e. low credit rating or unrated) and compensates investors by paying a relatively higher coupon for this additional credit risk. In the US and Europe, the high-yield bond market is large (US$1.4 trillion in the US and ~$420 billion in Europe) and closely watched by many analysts and market commentators as a gauge for corporate default rates and broader economic health.
Figure 1. Global US dollar-denominated high-yield bond market size
Source: JP Morgan
While bank debt is typically the funding norm for Australian companies, the growing regulatory burden bestowed upon the domestic banking system has ensued some limitations on risk-based lending exposures. As a result, a number of unrated companies have bypassed the banks and engaged capital markets by issuing high-yielding fixed income instruments. This includes listed transactions such as Peet Bonds (ASX: PPCHA), IMF Bentham Bonds (ASX: IMFHA) and URF Notes I, II and III (ASX: URFHA, URFHB, URFHC) and unlisted (over-the-counter/wholesale) transactions from issuers such as Capitol Health (ASX: CAJ), NextDC (ASX: NXT), G8 Education (ASX: GEM) and Cash Converters (ASX: CCV). We note that the Alumina 7.25% 2019 XTB (ASX: YTMAWC) has also became a high-yielding instrument following a double notch credit downgrade which triggered coupon step-up clause. In a global context, these securities would constitute high-yield bonds.
Figure 2. High Yield Bond Issuance in Australia
Source: BondAdviser
For investors wanting to take a more diversified approach, an alternate option for high yield exposure could be the iShares Global High Yield Bond (AUD Hedged) ETF (ASX: IHHY). The fund tracks the performance of the Markit iBoxx Global Developed Markets Liquid High Yield Capped Index which measures the performance of global high-yield bond markets, primarily in the US (~64% weighting) and Europe (~27% weighting). Following a strong year for the sub asset-class, the fund has returned ~15% in 2016.
Figure 3. iShares Global High Yield Bond (AUD Hedged) ETF Performance Index
Source: Blackrock
While the Australian fixed income market remains underdeveloped relative to its global counterparts, the growing trend of high-yield issuance is a positive step forwards and we are expecting further high-yield bond issuance in 2017. These types of high-income instruments fit in the realm of traditional fixed income and are typically less structurally complex than hybrids. This makes credit risk the standout when analysing high-yield bonds and highlights the importance of independent credit analysis.