Climate Transition Global High Yield Strategy

Sarah Harrison: In January of this year, we presented four global high yield themes for 2024 with a view on how each of these would play out. Let's see how we did. Firstly, we proposed that concerns about the sizable maturity wall on high yield were exaggerated. Over the course of 2024, short-dated maturities have so far been dealt with in an orderly fashion and not just 2024 maturities, but prefunding of 2025 and 2026 maturities has occurred, as well. The primary market has remained wide open and default rates have remained relatively contained. Secondly, we proposed that concerns around a zombie apocalypse in the high yield space were overdone. While higher rates have eaten into levered free cash flow generation, EBITDA has remained more resilient than anticipated and as a result, distress ratios have materially improved over the course of the year. Thirdly, we proposed that transaction activity, which would bring about very welcome net new issuance and idiosyncratic opportunities, would increase. This has happened but not yet to the extent that we had hoped. We have seen investment banking revenues come off the troughs and a selection of new issuers as a result of LBO activity picking up, but we can't earnestly say this is significant yet. As well, IPOs, particularly in Europe, still seem to be on the back burner. Finally, we proposed that central bank activity would be a key driver in selecting a geographic overweight. We positioned as overweight Europe versus the U.S. in the belief that Europe would have a steeper cutting trajectory than the U.S. As of mid-November, European high yield is set to outperform U.S. high yield this year on a hedged basis. So, what are we paying attention to and how are we positioning for 2025? The key view that underpins our 2025 outlook is that we will see central bank policy divergence around the world with higher for longer in the U.S., high-ish for longer in the UK, and a continuation of the cutting cycle in Europe, though possibly less steep of a trajectory than expected. Firstly, we are looking for the potential for a correlation breakdown between high yield and equities. High yields has historically been very correlated with equities, but if you look at the driver of the small cohort of companies in distress today, this distress has been driven by high interest burdens eating into cash flow rather than significant top-line declines. We believe that rate hikes will be more helpful to high yield companies than strong growth. So, we will continue to run with an overweight to Europe where we expect more rate cuts in the U.S. and have added to this position in recent weeks. Secondly, we anticipate default rates will continue to rise from here as a result of a higher for longer environment but remain contained. We still believe this will be mostly orderly where shareholders and bondholders are aligned and expect to see more distressed exchanges. That being said, we do recognize the increase in drop down transactions and uptiering and will continue to stay vigilant. We do not expect “muddle through refis” to get done anymore. As a result, we are highly selective when moving down the credit spectrum, underweight CCCs, and demonstrating discipline in a period of exuberance. Thirdly, we are doubling down on the view that transaction activity will continue to pick up, but new issuance to fund this will be easily absorbed by an uptick in fund flows, among other sources of capital. They should continue to be supportive of the technical and keep credit spreads rangebound with global high yield remaining attractive on an all-in yield basis.