High yield, low visibility.
That’s how many investors are feeling about high-dividend securities these days as interest rates edge higher and U.S. economy shows signs of recovery.
Historically, high-yield investments tend to outperform the S&P 500 in the three years following a recession, Isaac Braley, the president of BTS Asset Management, told CNBC’s “ETF Edge” this week.
But investors have been piling into the space in recent years amid a market-wide hunt for yield, “giving money to this asset class, really hoping it will do something,” Braley said in a Monday interview.
“Last year, it didn’t even cover its yield. So, there is pent-up opportunity in many of these different areas,” he said.
One such area could be the energy sector, Braley said, noting that oil companies typically need crude prices above $50 a barrel to be profitable, and now, they’re above $60.
“With defaults last year, so many … energy companies weren’t going to be buying the lease or the equipment of a failing company. Today, they’re able to,” he said. “There’s still companies not able to meet costs and are going to go under, but others can jump in there. That will push recovery rates up. That will help out the markets.”
“Zombie companies,” or highly indebted entities that continue to operate despite being unable to meet their debt obligations, still pose a challenge in the high-yield space, however, Braley warned.
“They’re getting free access to debt, they’re able to roll over debt with these very, very low rates, but will they be able to generate profits that can cover those?” he said. “That’s the challenge over the short term and that’s why high yields have really … flatlined here for a little while as they’re trying to see what’s real about the economy. Stocks can jump off into the future very easily, but high yields have a maturity date attached to them. They can’t do that.”
Even so, “the overall quality of the universe” has been improving, Stephen Laipply, managing director and head of U.S. iShares fixed income strategy at BlackRock, said in the same “ETF Edge” interview.
In the last 10-15 years, the number of BB-rated investments have gone from roughly one-third of the high-yield market to around 50%, while CCC-rated investments have decreased to the low teens from around 20%, Laipply said.
“The overall health of the universe has been improving over time,” he said. “Upgrades are outpacing downgrades right now in high yield. We’re seeing improvements right now in fundamentals in terms of interest coverage and even recoveries are starting to edge up. If you’re thinking about that long-term income carry trade, you have to believe that there’s going to be a hand-off from the current stimulus measures into longer-term growth in the economy and that those fundamentals will persist and allow you to continue that income.”
Provided Treasury yields continue to rise gradually, the yields for high-dividend investments should also climb, said Laipply, whose firm runs the popular iShares iBoxx $ High Yield Corporate Bond ETF (HYG).
Those searching for the best return per unit of risk may want to avoid the high-yield space altogether, John Davi, the chief investment officer and founder of Astoria Portfolio Advisors, said in the same interview.
“You get all the downside but not a lot of the upside, so, you’ll just never convince me that you’re better off owning high yield credit compared to a high-dividend-paying stock or an ETF,” Davi said.
He noted that over the last decade, the SPDR S&P Dividend ETF (SDY) has delivered double the compound annual growth of HYG despite having a slightly higher risk profile.
“I just think there’s better places to put your money,” Davi said. “Our big view … is that 10-year is going much higher. I think it’s going to be closer to 3% where this thing goes. We’re just printing money and there’s just a ton of supply out there, and I don’t see anyone looking to step in and buy these bonds.”
