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US High Yield and Leveraged Loan Strategy Summary

Core Content Overview

This document provides a detailed analysis of the current positioning and performance of the US High Yield and Leveraged Loan markets as of May 2025. It outlines the strategy team's recommendations for asset allocation, sector performance, and market dynamics, emphasizing the impact of macroeconomic conditions, policy risks, and credit quality shifts.

Key Recommendations

High Yield Factor Recommendations

• Deep Distress: Underweight (0.9% weight, YTW 40.71%, Price $41.61, OAS 3,206bp, OAD 3.04y)
• Transportation: Underweight (2.8% weight, YTW 6.69%, Price $99.25, OAS 253bp, OAD 2.65y)
• Fallen Angels: Underweight (6.5% weight, YTW 7.13%, Price $95.09, OAS 301bp, OAD 3.62y)
• Energy: Underweight (10.7% weight, YTW 8.13%, Price $96.22, OAS 397bp, OAD 3.33y)
• Communications: Overweight (14.1% weight, YTW 8.68%, Price $93.03, OAS 458bp, OAD 3.10y)
• Long Duration: Underweight (6.2% weight, YTW 6.60%, Price $93.52, OAS 226bp, OAD 5.54y)
• YTC: Underweight (2.0% weight, YTW 6.26%, Price $103.23, OAS 194bp, OAD 0.50y)
• Regular Way BB: Overweight (27.1% weight, YTW 6.35%, Price $98.56, OAS 225bp, OAD 3.01y)
• Regular Way B: Underweight (23.7% weight, YTW 7.80%, Price $97.13, OAS 369bp, OAD 2.90y)
• Regular Way CCC: Overweight (6.0% weight, YTW 10.62%, Price $90.73, OAS 653bp, OAD 2.79y)

Leveraged Loan Factor Recommendations

• Distress: Underweight (1.4% weight, Price 55.73, DM 2482bp, % Above Par 0.0%, WAL 3.06y)
• Communications: Overweight (10.0% weight, Price 97.57, DM 472bp, % Above Par 24.4%, WAL 4.19y)
• Transportation: Underweight (3.2% weight, Price 99.51, DM 255bp, % Above Par 41.4%, WAL 4.51y)
• BBB/BB:
  • Premium: Overweight (13.3% weight, Price 100.21, DM 212bp, % Above Par 89.2%, WAL 5.11y)
  • Discount: Underweight (9.2% weight, Price 99.11, DM 262bp, % Above Par 14.8%, WAL 4.87y)
• B+/B:
  • Premium: Underweight (18.4% weight, Price 100.17, DM 303bp, % Above Par 77.9%, WAL 4.70y)
  • Discount: Overweight (26.8% weight, Price 98.20, DM 385bp, % Above Par 11.4%, WAL 4.81y)
• B-/CCC:
  • Premium: Overweight (4.6% weight, Price 100.18, DM 358bp, % Above Par 83.3%, WAL 4.04y)
  • Discount: Underweight (13.0% weight, Price 96.36, DM 495bp, % Above Par 8.0%, WAL 4.05y)
• 2nd Liens: None
• High Yield Bonds: None

Asset Allocation

• Allocation Shift: In April, the team increased bond allocation to 55% and reduced loan allocation to 45%, reflecting a belief in bonds offering better upside/downside potential than loans.
• Performance:
  • Composite Return: 1.02% for High Yield, 0.69% for Loans
  • Allocation Return: 0.99% for High Yield, 0.36% for Loans
  • Relative Performance: HY outperformed Loans by 0.66% in January, 0.33% in February, and so on.

Market Dynamics and Outlook

• Energy Sector: Flipped from overweight to underweight due to economic uncertainty, OPEC+ supply concerns, and negative convexity of energy valuations relative to oil prices.
• Loan Market: Loans have largely recovered from March and early April losses, but the market is becoming more selective. The B- Tracker has grown significantly, with CLOs playing a dominant role.
• Credit Quality: The high yield market has seen a significant improvement in credit quality, with BB gaining 7% market share. However, much of this is due to the increase in secured paper.
• Duration: The market's duration has shortened to 3.35y, compared to a 4.0y average over the past 20 years.
• Bond vs Loan Yields: For the first time in two years, bond yields (swapped to 4y) have exceeded loan yields.
• Fund Flows: HY experienced a record outflow, while loan ETFs now make up nearly half of total loan fund AUM. However, HY spreads are not expected to widen significantly in the long term.
• Spreads and Risk: The current spread levels are historically narrow, but the team warns that in a severe downturn, spreads could approach 900-1000bp.

Forecast and Outlook

• Issuance: High Yield issuance is expected to rise to $370B by YE25, while Loan issuance is projected at $530B.
• Spread: Forecasted to be around 375bp for HY and 436bp for Loans.
• Price: Expected to rise to $95.62 for Loans, with HY at $94.76.
• Default Rate: Forecasted to be 1.8% for HY and 7.3% for Loans.

Conclusion

• Bond Allocation: The team recommends a 55/45 bond/loan allocation, with a preference for bonds due to their better upside potential and relative value.
• Structural Changes: The high yield market has become higher quality and shorter duration, which could affect spread resilience in future downturns.
• Market Outlook: While the market is currently in a narrow spread environment, the team anticipates potential widening in severe economic conditions.