James Keenan

Over the nearly six years since the 2008 financial crisis, high yield bonds and loans have been among the best-performing asset classes in global financial markets. Impressive, to be sure, but does that mean things are due for a turn?

Jim Keenan, Chief Investment Officer of the Leveraged Finance team and the lead portfolio manager for high yield portfolios, says a slowdown from the highs might be in the cards, but high yield still deserves consideration in investor portfolios.

What is your current outlook for high yield?

Relative to other fixed income assets, conditions for high yield bonds generally remain favorable: The economy is improving and companies are exhibiting strength. The Fed, while removing stimulus, is still accommodative, and inflation looks set to remain low given the slack in the labor market. That said, the cycle has evolved considerably over these last several years and high yield pricing is closer to fair value.

Is it time to start shifting out?

Not in our view. Both high yield bonds and loans still make sense in investor portfolios. You have a low-duration, or in the case of loans, a no-duration asset class that offers a level of protection from volatile interest rates. The economy is improving, underlying company risk is still low and defaults should remain muted. (Trailing 12-month default rates are currently 0.6% for high yield bonds and 1.6% for loans.)

We don’t think either asset class is a sell until the economy begins to slow and default risk rises, and that is most likely on the other side of Fed action to raise rates—still a ways away. It is, however, time to start adjusting your expectations. This year is not going to be exactly like
the last few.

History Bodes Well for High Yields Bonds, Loans

Why include high yield bonds and loans in my portfolio?

In addition to having lower exposure to interest-rate risk, high yield bonds continue to represent a good source of incremental income. They also happen to be a good fixed income diversifier because, directionally, high yield bonds tend to follow equities more so than other fixed income assets. Both equities and high yield bonds are inherently tied to company health: equities in companies’ ability to grow earnings or dividends, and high yield in companies’ ability to pay back debt. So, what’s good for equities is good for high yield; and what’s bad for one is bad for both. Notably, high yield traditionally has traded with much less volatility than equities.

For their part, loans represent a source of income that is not interest-rate sensitive like most other fixed income instruments. They provide a high level of income based on credit spreads, with floating-rate exposure to rates that helps preserve their value. This is different from fixed-rate instruments, which makes loans a diversifier for fixed income and an instrument not beholden to what the Fed decides to do to the Treasury curve. In the past, people might have looked at loans as an alternative. Today, more often than not, loans are considered a core investment.

High Yield and Loans: Key Elements in a Diversified Portfolio

How should I gain my high yield exposure?

High yield markets, both bonds and loans, are complex. Not only are you dealing with the inherent credit risk (risk of default and loss of principal and income), but also idiosyncratic sector-, issuer- and credit-specific considerations that can make or break a portfolio. There
is a lot of opportunity, but individual credit research and good risk management are critical, particularly at transition points, which is where we are now.

We recommend investors gain their exposure via a professionally managed high yield product, where the onus is on the investment team to navigate these complexities. Here at BlackRock, we are very dynamic across the economic cycle and the credit cycle. We’re seeking the best risk-adjusted returns and we’re very specific about what we own. When risk is appropriately priced in the market, we will go down in quality and buy it. When it’s not, we will become very defensive.

And it’s personal. We put our money where our mouth is. Our team members invest in our funds, so we’re stakeholders, just like our investors. We think that really speaks to our conviction in the asset class, and particularly to our approach to investing in it.

Investing involves risk, including possible loss of principal.

Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions.

International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets, in concentrations of single countries or smaller capital markets.

Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.

Please consider the investment objectives, risks, charges and expenses of each fund carefully before investing. The funds prospectuses and, if available, the summary prospectuses contain this and other information about the funds and are available, along with information on other BlackRock funds, by calling 800-882-0052. The prospectus and, if available, the summary prospectuses should be read carefully before investing.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are those of the investment professionals profiled as of June 2014, and may change as subsequent conditions vary. Individual portfolio managers for BlackRock may have opinions and/or make investment decisions that may, in certain respects, not be consistent with the information contained in this report. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks.

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