Accounting for Disruptive Forces within the Fixed-Income Markets
Continued economic growth and generally solid corporate profits have provided a positive backdrop for the U.S. credit market. This is reflected in overall sound fundamentals, low defaults, and tightening spreads. But, if we peel back the onion, we see a number of disruptive forces across a variety of industries that have led to increased idiosyncratic risk. In our view, avoiding issuers being negatively impacted by these forces and, conversely, identifying credits poised to capitalize from shifting markets will be keys to generating solid returns.
Retail Being Reshaped
The Amazon effect is significantly reshaping the retail industry, and this trend is expected to gain further momentum. Mall-based retailers are struggling, as consumers embrace the click-and-buy versus a brick-and-mortar model. As Figure 1 illustrates, the high-yield retail segment presents attractive valuations after a volatile year. However, disruptive forces are creating structural shifts that have caused us to avoid such exposure in our portfolios.
Figure 1: Yields Vary Significantly across Industries; Disruptive Forces Must Be Kept in Mind When Assessing Opportunities
Source: Barclays Research, Yield-to-Worst as of 10/31/17. High-yield corporate bonds are represented by the JP Morgan U.S. High Yield Index.
Investment-grade corporate bonds are represented by the Bloomberg Barclays U.S. Corporate Investment-Grade Bonds Index.
Detours in the Auto Industry
We’ve identified two particularly important disruptive forces in the auto industry that warrant investors’ attention: electric vehicles (EVs) and ride sharing. EVs are shaking up the industry, as virtually all major auto manufacturers are joining the electric revolution. As the adoption of EVs continues, it will crimp the revenues of axle and transmission manufacturers and companies leveraged to the combustion engine—many of which are high-yield issuers. As a result, we are focused more so on investment-grade opportunities that are better positioned for the future. While the segment generally presents less of an income opportunity at this point in time, per Figure 1, long-term risk/reward profiles are more favorable in our view. Meanwhile, the ripple effect of ride sharing is impacting a number of industries. Car rental companies, for one, are feeling the pinch, as more travelers realize that it’s often cheaper and more convenient to use services like Uber and Lyft.
The Health of Health Care
The health care system is also seeing change, with hospitals, in particular, being impacted. In the high-yield space, large for-profit hospitals are facing disruption manifested by declining margins, as one of the most profitable business segments—emergency rooms—is losing market share to outpatient surgery centers. Patients are being drawn to the latter, as they receive quicker service and lower costs versus emergency room care. Despite relatively attractive yields, we have avoided exposure to the segment, based on the potential for continued margin compression over time.
Bifurcation of Telecom: Wireless over Wireline
In the telecom industry, the shift from wireline to wireless has been an ongoing trend, and we have been favoring wireless for quite some time. Drilling down further, we see opportunities and challenges in both the investment-grade and high-yield markets. On the investment-grade side, AT&T and Verizon are in a battle to retain market share and average revenue per user (ARPU) in an increasingly competitive pricing environment, as high-yield constituents, such as Sprint and T-Mobile look to add customers. Meanwhile, the buildout of the 5G network could result in transmission speeds equal to or faster than fiber, which will require more and more spectrum. In short, spectrum is the range of electromagnetic radio frequencies used to wirelessly transmit sound, data, and video. The quantity and quality of spectrum that carriers possess will be increasingly important, given the need to move large volumes of data at high speeds.
Figure 2: Quantity and Quality of Spectrum Increasingly Important in Data-Driven World
Source: Sprint, “In the Land of Unlimited Wireless, Spectrum is King”, 2/15/17.*Nationwide, population-weighted average spectrum assets as of 2/7/17. These numbers are national averages and do not represent the spectrum assets in any specific market. MHz = Megahertz.
We continue to find compelling opportunities in both the investment-grade and high-yield credit markets. Given current spread levels, we believe thorough credit analysis will take on added importance. A critically important component of this analysis will be accounting for disruptive forces across various industries and leveraging insights to identify credits from issuers poised to benefit, while avoiding those issuers we view as more likely to be left behind.
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There is no assurance that the investment objectives can be met. It is not possible to invest directly in an index. All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.
Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
A portion of the municipal bond fund’s income may be subject to state and local taxes or the alternative minimum tax. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Funds that invest in bonds are subject to interest-rate risk and can lose principal value when interest rates rise.
High-yield securities carry higher risks and some of the Fund’s investments have speculative characteristics and present a greater risk of loss than higher-quality debt securities. These securities can also be subject to greater price volatility.
The Amazon effect is the ongoing evolution and disruption of the retail market, both online and in physical outlets, resulting from increased e-commerce.
The Bloomberg Barclays U.S. Corporate Investment Grade Index is a market-weighted index that includes publicly issued US corporate and specified foreign debentures and secured notes that meet the maturity, liquidity and quality requirements.
A credit spread is the difference in yield between two bonds of similar maturity, but different credit quality.
JP Morgan U.S. High Yield Index is designed to mirror the investable universe of the U.S. high-yield corporate debt market, including issues of U.S.- and Canadian-domiciled issuers.
The yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. The YTW is calculated by making worst-case scenario assumptions on the issue by calculating the return that would be received if the issuer uses provisions, including prepayments, calls or sinking funds. This metric is used to evaluate the worst-case scenario for yield to help investors manage risks and ensure that specific income requirements will still be met even in the worst scenarios.
MacKay Shields LLC is a federally registered investment advisor and an affiliate of New York Life Investment Management LLC. MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. The MainStay Funds® are managed by New York Life Investment Management LLC and distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302, a wholly owned subsidiary of New York Life Insurance Company. NYLIFE Distributors LLC is a Member FINRA/SIPC.