Fridson: Which high-yield industries are faring best amid rate hikes?

This commentary is written by Martin Fridson, a high-yield market veteran who is chief investment officer of Lehmann Livian Fridson Advisors LLC as well as a contributing analyst to Leveraged Commentary & Data.

The ICE BofA US High Yield Index’s option-adjusted spread, or OAS - roughly defined as the difference between a speculative grade bond’s yield and the yield of a U.S. Treasury bond of similar maturity - reached its monthly low on Sept. 12, at +450 bps. From that date through Sept. 23, the spread swelled to +512 bps, its high for the month up to then. 

Key to that step-up in the speculative-grade risk premium was a growing realization that Jerome Powell and his fellow Federal Open Market Committee members really meant it when they said they were going to stick to their guns in bringing inflation down. The change in market tone culminated in a 0.75-percentage-point hike in the target Fed funds rate on Sept. 21, accompanied by indications from Powell that the rate would rise and the economy would likely slow more than previously expected.

Some high-yield boosters tried to make the case that their asset class was now more attractive than equities or high-grade bonds. They cited long-run breakeven rates involving the spread-versus-Treasuries and expected default losses, which of course have little or nothing to do with near-term returns. In any case, asset allocation is the province of the institutional client or mutual fund shareholder. Managers of dedicated high-yield funds are primarily concerned with generating the highest (or least negative) returns possible within their assigned asset class.

Industry allocation is one potential path to achieving superior relative performance. For portfolio managers who expect returns to remain under pressure from a combination of rising interest rates and weakening economic activity, a breakdown of the most recent selloff can shed light on where the most pain will be felt. The table below provides such a breakdown.

This analysis is not limited to the 20 largest high-yield industries by face amount outstanding that we cover in our monthly updates of returns and industry relative value. Instead, it covers all 37 discrete ICE BofA US High Yield industry subindexes. (The table displays returns for the Gaming index and the Hotels index, for example, but not the combined Hotel & Gaming index.)

Bear in mind that one reason we usually focus on the 20 largest industries is that the smallest industries may be subject to high levels of statistical noise. In an extreme example, the once significant Railroad index has dwindled to a single issue, rated Caa1/B- (see note 1). With that caveat, some useful themes emerge from the ranking by recent returns.