2012 US HIGH YIELD MARKET OUTLOOK

Transcription

1 Q1: What are the impacts of the prolonged interest rate environment, fiscal budget tightening and possible QE3 to the US High Yield Market? So, it's really impossible to look at each of those variables in isolation because one will impact the other. But generally speaking, US high yield will perform well in a relatively-low interest rate environment. So long as interest rates don't spike up, in a short period of time, US high yield will perform relatively well. Similarly, if we did see another round of quantitative easing, it would be a positive development for all asset classes, including US high yield, and with respect to any potential fiscal budget tightening, we'll really wait to see where it impacts the potential economy, and we'll have to do the analysis to figure out which companies would be most impacted and which companies wouldn't see much of an impact. But, in the long term, I think that would be a favorable macro economic development for the US economy. Q2: What has issuance been like in the US High Yield market recently; are issuers still able to refinance their existing debt? We've seen record new issuance in US high yield for the last two-plus years, and in fact, in the first quarter of 2012, we're on pace to break the previous record of over $250 billion of new issuance in These are very favorable developments for the US high-yield asset class. It means that a lot of our debt is being repaid at a premium to where it s trading, so we benefit right away from that aspect. And from a corporate balance sheet perspective, companies have taken advantage of this low interest rate environment to reduce their overall cost of funding and to extend their maturity profiles, which should mean lower default rates in the asset class going forward, which will benefit the performance for high Page 1 of 7

2 yield. So all of this leads to good performance in high yield and the trend does continue so far here in Q3: What do you think about valuation of US High Yield at the moment and what are your expectations for 2012 in terms of spreads and defaults? Right now, valuations in US high yield are fair. The average yield is a little over seven percent and the risk premium, as measured by the spread over treasuries, is a little under 500 basis points over treasuries. But the good news is the fundamentals look very strong. So, offsetting the relatively-tight spreads versus the long-term average is the fact that the default rate in the marketplace is expected to stay below three percent over the course of This compares to the long-term average annual default rate of about five percent. So as long as that default rate stays at low levels, spreads should continue to stay roughly where they are or could potentially even tighten in from here. But my base case expectation is over the next 12 months, the asset class will basically return the coupons, so a little over seven percent, and spread will stay roughly where they are. Q4: How has the turmoil in Europe and the slowdown in global growth impacted US corporate earnings? Have the recent downgrades of European countries had any impact on the US High Yield market? Let me begin by saying, and make this absolutely clear to investors, we are not investing in any type of sovereign debt. This is solely a corporate bond fund investing in US dollardenominated bonds. Page 2 of 7

3 What's been happening across Europe has certainly impacted the performance of US high yield, less so from a fundamental perspective, and more from a risk appetite perspective. So, with the credit crisis really reaching its peak in the second half of 2011, a lot of risk asset classes sold off, US high yield was not immune from that sell-off. Fundamentally, most of the companies that we're investing in are, of course, global companies, and they compete in a global marketplace, but fundamentally speaking, while they may have seen a little bit of a deterioration in their top-line performance, it was nothing significant. So US high-yield companies continue to generally benefit from the improving economy that we're seeing here in the United States, which more than offset any little slowdown that they saw as a result of what's happening in Europe. Q5: What are the major opportunities and risks to the US High Yield in 2012? I think the biggest opportunity is what my base case economic outlook is, and that is continued improvement, slow growth, which should allow interest rates to stay low and companies continue to generate improving profitability. And if that scenario plays out, US high yield will continue to perform very well for investors. The biggest risks would be tied to something more along the lines of what we saw in the second half of 2011, which would be a sovereign debt crisis escalation, again in coming out of Europe, or a dramatic slowdown in Asia, to the extent that it causes some sort of a more magnified global economic recession. Page 3 of 7

4 Q6: Which sectors are you overweighting or underweighting and why, and can you also discuss your current positioning with the financial sector? At this point in the credit cycle with valuations where they are, I can actually get paid the same yield investing in a defensive industry as I can in a more cyclical industry and so given that backdrop, I think it makes more sense to be overweight the industries that I have big exposure to. Some examples would be healthcare, telecommunications, or utilities. These are all industries that provide services that consumers need, regardless of what happens in the economy. I am also very much overweight diversified financial services, and while each company that I'm investing in within that sector is very different, so for example, one may be an airline lessor or one may be a specialty finance company, all of these companies have one common theme, and that is coming out of the financial crisis, each of these companies want to improve their balance sheet, improve their credit rating, and therefore, reduce their cost to borrowing. That's critically important to a finance company. And as a result, they have strong balance sheets that are getting better, and I think these companies will perform extremely well, regardless of whether US high yield is in a down market or in an improving market. We have good downside protection, and my base case expectation is, as their ratings improve, they ll see spread-tightening, and we'll actually get capital appreciation on top of the high current income. So, those are some of the industries that I am overweight. An example of an industry that I'm underweight currently would be something like homebuilding, where, again, I'm not getting paid a lot for the incremental risk that I see fundamentally for the US housing market recovery. Page 4 of 7

5 Q7. Can you discuss how you make the decision to allocate to equities? Do you rely on Fidelity s equity research team for analysis? The vast majority of the equities that the fund holds, which is not a very significant position, historically has been well under five percent of the overall portfolio, but the majority of the equity positions that we do have are securities that we've taken back through restructurings. So sometimes, a company will go into default and the bond holders will take back equity in the reorganized company, and a lot of times, we see great value and opportunity in these distress situations. So, they are generally done on a very specialized one-off basis where we see great opportunity for total return. It's not a major part of the overall portfolio. So when it comes to research, looking for specific equity ideas, we're much less focused on the equity research coming out of our equity group. But I'd really be remiss if I didn't talk a little bit about the huge benefits that we get being part of the broader Fidelity Investments. So being co-located with the equity division gives us access to hundreds of investment professionals around the globe and unparalleled access to the senior executives of management teams across industries, whether they are investment-grade companies or non-investment-grade companies, and that means we're getting incremental color and data points every single day on what's happening across industries and across regions around the globe, so being part of the equity group here at Fidelity is a huge competitive advantage that we have in the High Income Division. Page 5 of 7

6 Q8: What is your view on US corporate earnings from a bottom-up approach? Right now, from a bottom-up approach, what we're hearing from our companies is demand continues to be solid. Companies have done a tremendous job of taking cost out of their cost structure coming out of the credit crisis, and so any growth that we're seeing in the topline, is really resulting in margin expansion for most of the companies that we're talking to. So again, the color that we're getting today is the business outlook, generally speaking, is good for most companies across most industries and they feel good about their prospects. Q9: What is the major advantage of US High Yield market over other High Yield markets? Well, let me start more generically in just talking about the great benefits of investing in US high yield because over time, this has really been shown to be a superior asset class. This is an asset class that offers investors a superior risk-adjusted return profile over time, the opportunity to get high absolute total returns, and most of that comes in the form of high current income. And when you layer in on top of that the fact that US high yield has relatively-low correlation with other asset classes, I think it makes for a very compelling story as to why most investors should have a dedicated part of their diversified portfolio invested in US high yield. Now, looking at US high yield versus some of the other high yield asset classes around the world, it's important to understand that US high yield was really the first high-yield asset class, and as a result of that, it is a much bigger, more diversified asset class. So by way of example, it's roughly six times the size the European high-yield market and about 20 times the size of the Asian high-yield market. So with this comes a significant amount of Page 6 of 7

7 increased diversification opportunities, liquidity in the marketplace, and just a longer-term history. - End - FIL Limited and its subsidiaries are commonly referred to as Fidelity or Fidelity Worldwide Investment. Fidelity only gives information about its products and services. Any person considering an investment should seek independent advice on the suitability or otherwise of the particular investment. Investment involves risks. Past performance is not indicative of future performance. In general fluctuation in the performance of emerging markets is normally higher as it tends to be more volatile than other developed markets. Please refer to the Fidelity Prospectus for Hong Kong Investors for further information including the risk factors. If investment returns are not denominated in HKD or USD, US/HK dollar based investors are exposed to exchange rate fluctuations. Fidelity, Fidelity Worldwide Investment, the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited. The material is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Futures Commission ( SFC ). Page 7 of 7