Global High Yield Still Offering Value - Aberdeen Asset Mgmt

8/13/2019 Global High Yield Still Offering Value - Aberdeen Asset Mgmt

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Global high yield:

We believe its still offering valueDecember 2013


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At Aberdeen Asset Management, we believe Global High Yield and U.S.

High Yield markets are still offering value given the back drop of sloweconomic growth and credit trends that still appear favorable for

investors. In this type of environment we expect default rates to remainlow by historical standards which may continue to support valuations acurrent levels. For example over the last years the spread differential

between the high yield bond market and the trailing month parweighted default rate has averaged .% (.%-.%). Today that

spread is over % wider than the historical average (.%-.%)and is currently trading at .%.What this means is that if we buy themarket and experience the default rates priced into the market we belie

we can achieve the historical results observed in the last example. Keepmind default rates are priced into the market and given our experienc

we believe we can effectively manage this default process and potentiadeliver an above-market return. In addition we also have to factor in the

yield curve and the intrinsic value of individual issuers which will also ad

to the value proposition.

High yield default rates vs spreads

0

20

18

160

14

120

10

80

60

40

20

High Yield Default Rates (left-hand side)1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

0

2

4

6

8

10

12

14

16

(%)

High Yield Spreads (right-hand side)

Spread 25 yraverage = 592 bp

Default rate 25 yraverage = 3.93%

Sources: JPMorgan, November 2013.For illustrative purposes only.

Global high yield: we believe its still offering value

Patrick Maldari is a Senior Portfolio Manager on the North American

Fixed Income team. Patrick joined Aberdeen in May followingthe acquisition of Artio Global Management. From ,Patrick held a similar role with Artio Global Managements Fixed

Income Group. Prior to that, he spent twenty-two years at Merrill

Lynch Investment Managers where he rose to become a ManagingDirector and Fixed Income Portfolio Manager. Patrick received his BSdegree from Montclair State University and is a Chartered FinancialAnalyst. CFA and Chartered Financial Analyst are trademarks

owned by CFA Institute.

CFA and Chartered Financial Analyst are trademarks owned by CFA Institute.

Patrick Maldari, CFA

Senior Portfolio Manager

North American Fixed Income

Risks of investing in high yield securities

Investments in high yield bonds and other lower-rated securities present substantial risk of loss. Derivatives are speculative and present therisk of disproportionately increased losses and/or reduced gains when the financial asset or measure to which the derivative is linked changesin unexpected ways. Other potential risks include economic growth risks, inflation risks, liquidity, supply and external shocks. Additionally, high

yield securities have higher transactions costs and are more likely to contain call provisions, which allow the issuer to call a bond for redemptionbefore it matures.

(basis poin

JP Morgan, November 2013


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In addition to default cost and current valuations, there are several otherfactors to consider:

. Rising Stars versus Falling Angels

Over the last four years there hasbeen considerable overall credit quality improvement as morecompanies have moved from the high yield sector to the investment-

grade debt category (rising stars). In fact, billion worth of high yieldissuers have moved up in quality and are no longer in the high yield

universe (see Chart below). This has also helped to absorb some ofthe new issuance that has taken place so far in and, in fact, the

net impact on the high yield market is at an historical high.

Chart : Rising star volumes outpacing fallen angels year-to-date(YTD)

0

20

40

60

80

100

120

140

160

1995

USD(

billions)

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

YTD

Rising stars Falling angels

Source: JPMorgan, October 2013. For illustrative purposes only.

. Default rate cycle We believe that we are still in the middle inning

of the default rate cycle. Typically after peaks in defaults such as theone that we witnessed in late , the default rate may continue to

trend lower and then bounce along at the lower end of the range. Wefeel that this cycle could be more prolonged than others due to theimpact that the credit crisis has had on companies managing balance

sheets. In our opinion, defaults potentially could stay below long-termaverages (see Chart below).

Chart : Global speculative-grade default rate(%)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2013

Source: JP Morgan, Moodys, October 2013. For illustrative purposes only.Forecasts and estimates are consensus opinion and are not based on potentialperformance. Actual events or results may differ materially.

Falling angels refer to bonds that were once investment-grade but have since been downgraded to junk status.JPMorgan, October ,


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. Maturities The high yield asset class has witnessed a tremendous

amount of issuance in the last few years (. trillion gross issuanceglobally since )as it appears that investors search for income has

allowed companies to tap into this demand. Without knowing thedetails, this might seem to be a negative; however, after furtheranalysis, we believe that this huge issuance has actually been quite

positive for the sector. First, the bulk of this issuance (%) has beenissued simply to refinance existing debt;therefore, not a lot of net new

debt has been issued. The next important factor to consider is: Whathas this issuance done to the maturity profile of the high yield market?As illustrated in Chart , maturities have been extended and, in our

view, may give investors comfort that, in the near term, companies willnot need to issue debt at an inopportune time.

Chart : U.S. High Yield Market Average Maturities vs.

104.9 113.5

126.0

92.2

66.6

24.87.8 2.8 3.8 1.0

68.8

16.0

39.0

72.0

92.0

147.0

203.0

170.6

233.0

153.7

108.7

145.6

$0

$50

$100

$150

$200

$250

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023or laterDec-08 Jun-13

$b

illions

Year of maturity

Sources: JP Morgan, June 2013For illustrative purposes only.

. High yield and rising rates While we do not believe that rates will

move up significantly in the near term, the high yield asset class hasactually performed quite well in past periods when monetary policy

has been unfriendly to bond markets (see chart below). In fact onlytwo periods have produced negative returns when analyzing theperiods surrounding tightening cycles.One other benefit for the high

yield sector that normally is not discussed is what this higher rateperiod does to liabilities on the balance sheet. If rates were to rise

materially, the present value of these liabilities for these high yieldcompanies would drop sharply. We believe that this environment coupotentially allow these high yield issuers to be able to use free cash

flow to buy back debt at a discount and in effect de-leverage.

Chart : The Historical Impact of Rising Rates on the U.S. High Yield MarkRising Rate Period : February , -February ,

Calendar-year returns (before, during, after full period 1993 1994 1995 1996

Year-end fed funds rate 3.00% 5.50% 5.63% 7.00

Bank of America Merrill LynchU.S. High Yield Master II Index 17.18% -1.17% 19.91% 11.06

Rising Rate Period : June , - May ,

Calendar-year returns (before, during, after full perio

1998 1999 2000 2001

Year-end fed funds rate 5.00% 5.25% 6.25% 1.25

Bank of America Merrill LynchU.S. High Yield Master II Index 3.66% 1.57% -3.79% 6.21

Rising Rate Period : June , - June ,

Calendar-year returns (before, during, after full perio

2003 2004 2005 2006 2007

Year-end fed funds rate 0.94% 2.25% 4.00% 5.38% 3.00

Bank of America Merrill LynchU.S. High Yield Master II Index 27.23% 10.76% 2.83% 11.64% 2.17

Sources: U.S. Federal Reserve, Bank of America Merrill Lynch, June 2013For illustrative purposes only.PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.The BofA Merrill Lynch US High Yield Master II Index tracks the performance of USdollar denominated below investment-grade corporate debt publicly issued in the USdomestic market. Indices are unmanaged and are provided for comparison purposes

only. No fees or expenses are reported. You cannot invest directly in an index.

JPMorgan, June Ibid.U.S. Federal Reserve, Bank of America Merrill Lynch, June Before, during, after full period refers to the accounting for data for the previous, actual and subsequent years reported.


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. Excess spread over default costValuation can be measured asexcess spread over default cost, or the yield spread that remains afteraccounting for the cost of default and liquidity premium.Based on this

measure, we believe that there is value in the sector (see Chart below).When making very conservative assumptions about recovery rates and a

liquidity premium, we believe there is still excess return remaining.

Chart : Global High Yield MarketAs of November ,

Global high yield option-adjusted spread (OAS)over U.S.

Treasuries (basis points or bps)

Aberdeens default projection .%

Moodys recovery rate %

Expected cost of default (bps) -

Liquidity premium (bps) -

Remaining excess spread over U.S. Treasuries after default

and liquidity costs (bps)

Sources: Aberdeen Asset Management, Moodys, November 2013For illustrative purposes only. Index represented for OAS: BAML Global High YieldConstrained Index.

. Income can potentially absorb volatility As seen in Chart below,

over any substantial period of time, the potential income that highyield securities can provide historically has enabled the sector to

absorb a tremendous amount of volatility in price. Just look at pasthistory when prices are about where they are today (Chart shows firepresentative periods where the high yield market was priced similar

to current prices approximately US). As one can note, yields weslightly higher (about - bps) during these time periods as the U

Treasury yield curve was higher; however, over any significant timeframe, returns were positive except for the five year period thatincludes the fourth quarter of .

Chart : Income/total return can absorb volatility over time

Date // // // // //

High Yield Price . . . . .

Total Return (%)

Year . . . .

Years . . . .

Years . . -.

Years . .

*Returns for periods of more than one year are annualized.Sources: Aberdeen Asset Management, Bloomberg, December 4, 2013. For illustrative purposes only.PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.The above is representative of the Bank of America ML U.S. High Yield Index and selected periods are provided for comparison to the current price (approximately US$100). TheBank of America ML U.S. High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.Indices are unmanaged and are provided for comparison purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

Excess spread is remaining net interest payments from the underlying assets of an asset-backed security, after all payables and expenses are covered.Liquidity premium is a premium that investors will demand when any given security can not be easily converted into cash, and converted at the fair market value.The option-adjusted spread (OAS) is a calculation of the relative value of a fixed income security containing an embedded option, such as a borrowers option to prepay a loan. A large

OAS implies a greater return for greater risks.Forecasts and estimates are offered as opinion and are not reflective of potential performance, are not guaranteed and actual events or results may differ materially.Moodys estimates defaulted debt recovery rates using market bid prices observed roughly days after the date of default. Recovery rates are measured as the ratio of price to par valu


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Global High Yield Still Offering Value - Aberdeen Asset Mgmt

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