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High yield bonds started the year strong, posting solid returns despite a tough May. Senior secured loan returns have been lower, but the asset class has performed well nonetheless and held up better during May’s sell-off. The first quarter, plus April, was relatively smooth sailing. Especially in comparison to 2018’s tumultuous fourth quarter, risk assets broadly recouped their losses, and then some. Macro headwinds coupled with policy uncertainty injected some volatility in May; however, we expect leveraged credit will follow equity’s lead rather than drive volatility itself.

Even though we believe we are in the later stages of the current cycle, we still view the environment for credit as relatively favorable. However, the market seems poised to react if certain macro headwinds become more pronounced – a meaningful slowdown in growth, trade war escalations and Fed actions, or lack thereof, can all inject further volatility. We believe that value still exists in leveraged credit, but it may be harder to discern as we get later in the cycle. Fundamental analysis, while key at any stage of a cycle, will become increasingly important in a market where yield, or carry, is the primary driver of returns.

Both the high yield bond market and senior secured loan market have similar average yields to maturity, at 6.44% and 6.70%,1 respectively. Assuming stable price returns over the balance of the year, this would imply roughly 3% in additional return for both markets by year-end. While it may not be a straight line to get there, we believe this type of return outlook is reasonable.

1 Bloomberg.

All data as of June 30, 2019, unless otherwise noted.

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