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   High Yield Bonds

Safeguarding Leveraged Credit Portfolios Amid Heightened Interest-Rate Volatility

July 10th, 2013

by Team

of Guggenheim Partners

While rapidly deteriorating credit quality and excessive market leverage were the chief culprits behind the end of the previous credit rally in 2007, neither factor is currently a significant concern in the leveraged credit market. Interest-rate risk, specifically the market’s uncertainty regarding future monetary policy, precipitated the recent market sell-off and will likely continue to shape the performance of high yield bonds and bank loans in the near term.

Despite the parallels being drawn between current credit conditions and those of 2007, the chances of experiencing a sudden spike in near-term defaults, similar to what ensued following the end of the previous credit cycle, remain remote given the robust capital markets activity. While rapidly deteriorating credit quality and excessive market leverage were the chief culprits behind the abrupt end to the previous credit rally, neither factor is currently a significant concern in the leveraged credit market.

Interest-rate risk, specifically the market’s uncertainty regarding future monetary policy, precipitated the recent market sell-off and will likely continue to shape the performance of high yield bonds and bank loans in the near term. Amid increased interest-rate volatility and a gradual softening in underwriting standards, investors should seek to safeguard portfolios by shortening interest-rate duration and improving credit quality. While we continue to view bank loans as the preferred investment vehicle to achieve these dual objectives, the backup in bond yields has created an attractive re-entry point to selectively increase allocations to high yield bonds.

REPORT HIGHLIGHTS:

  • The Federal Reserve’s (Fed) announcement of possible tapering as early as the end of 2013 has caused investors to re-price risk. With yields on the 10-year Treasury note 82 basis points higher since May, current market conditions necessitate a greater focus on optimal positioning on the yield curve.
  • Investors’ preference for bank loans over high yield bonds is likely to persist until interest-rate volatility subsides. During the second quarter, high yield bonds lost 1.4 percent while bank loans returned 0.3 percent.
  • Credit conditions remain relatively benign compared to the experiences of 2006 and 2007. Analyzing market leverage and the financing terms of leveraged buyouts (LBOs) from the respective periods helps illustrate this contrast.

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IMPORTANT NOTICES AND DISCLOSURES

Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy or, nor liability for, decisions based on such information. This article is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product or as an offer of solicitation with respect to the purchase or sale of any investment. This article should not be considered research nor is the article intended to provide a sufficient basis on which to make an investment decision. The article contains opinions of the author but not necessarily those of Guggenheim Partners, LLC its subsidiaries or its affiliates. The author’s opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed as to accuracy. This article may be provided to certain investors by FINRA licensed broker-dealers affiliated with Guggenheim Partners. Such broker-dealers may have positions in financial instruments mentioned in the article, may have acquired such positions at prices no longer available, and may make recommendations different from or adverse to the interests of the recipient. The value of any financial instruments or markets mentioned in the article can fall as well as rise. Securities mentioned are for illustrative purposes only and are neither a recommendation nor an endorsement. Individuals and institutions outside of the United States are subject to securities and tax regulations within their applicable jurisdictions and should consult with their advisors as appropriate. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. © 2013, Guggenheim Partners, LLC.

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