High yield markets “pricing far worse default outcomes than we expect” – Man GLG’s Scott

High yield markets are pricing in a default scenario which, in my view, is too pessimistic, providing a range of opportunities for yield-hungry investors, Man GLG’s Mike Scott has said.

Default rates, particularly in the US which accounts for around 60% of the high yield universe, have ticked higher this year as the impact of the coronavirus starts to show despite the best efforts of central banks.

The trailing 12-month default rate is now at around 5.6%, according to Fitch Ratings[1], and while Scott expects this to climb to 10% in this cycle, he believes pricing in the market has moved too far.

“In my opinion, defaults may rise from here and peak at around 10%, mainly concentrated in consumer-facing sectors, as well as energy,” he said.

“However, such a scenario seems more than priced in. We therefore think valuations are compensating for a worse default outcome than the one we actually end up with.”

While the coronavirus has had an immediate and pronounced impact on the global economy, Scott said the economic backdrop was far more positive than many accept.

“Of course there are some clear risks on the horizon, but I believe they are not big enough to derail the economy,” he said.

“While this has been one of the worst recessions on record, it is also one of the shortest, and while spreads on high yield blew out initially, central bank actions coupled with fiscal easing seems to have bought stability.”

High yield debt has rebounded strongly from the lows seen when lockdowns were implemented earlier this year, with the IA Sterling High Yield universe returning some 3% over the past three months[2].

Scott, who manages the GLG High Yield Opportunities strategy, said risks remained in certain sectors, in particular in the US shale industry where he sees a potential default rate of 20% in 2020.

However, in some of the worst impacted sectors, I believe there remain some striking individual opportunities, especially with yields still trading at spreads of 500bps on average across the high yield universe.

“Airline debt as a sector is down 29.8% year-to-date, while entertainment is off 25.6%, but these COVID-disrupted sectors may offer some of the best opportunities, in my view” he said.

 

As at 30 June 2020, Man GLG had $26.6 billion in funds under management.

[1] According to Fitch Ratings https://www.fitchratings.com/research/corporate-finance/us-high-yield-default-volume-drops-significantly-in-august-19-08-2020#:~:text=For%20more%20information%2C%20a%20special%20report%20titled%20%22U.S.,on%20the%20Fitch%20Ratings%20web%20site%20at%20www.fitchratings.com.

[2] According to FE Trustnet, the IA Sterling High Yield sector delivered a return of 3% in the three months to 09/09/20. https://www.trustnet.com/factsheets/o/qe9m/man-glg-high-yield-opportunities