Q4 2021 Putnam High Yield Fund Q&A
- Following declines in October and November, high-yield bonds posted their strongest monthly gain of 2021 in December.
- Security selection in cable & satellite, technology, and utilities contributed the most versus the benchmark, while overweight exposure to broadcasting and picks in services detracted.
- We have a generally positive outlook for the market’s fundamental environment and supply-and-demand backdrop, but are more neutral toward valuation.
How did the fund perform for the three months ended December 31, 2021?
The fund’s class Y shares rose 0.73%, performing in line with the 0.74% return of the benchmark JPMorgan Developed High Yield Index.
What was the market environment like for high-yield bonds during the fourth quarter of 2021?
After posting negative returns in October and November, high-yield corporate credit registered its strongest monthly advance of 2021 in December [1.98%]. This came as concerns about the severity of the Omicron coronavirus variant receded. Strong stock market gains also bolstered the overall risk backdrop in December.
After declining in November, U.S. oil prices were volatile in December but worked their way higher, ending the period at about $75 per barrel.
The yield on the 2-year U.S. Treasury note jumped to its highest level since March 2020, reflecting investor reaction to a hawkish pivot by the U.S. Federal Reserve. Both the Fed and investors now anticipate three 0.25% increases in the federal funds rate during 2022.
Relative to other asset classes, high-yield bonds performed in line with leveraged loans but outpaced investment-grade [IG] corporate credit and the broad IG fixed-income market.
Within the fund’s benchmark, all but three cohorts achieved gains, although positive results were in a tight range. Diversified media, automotive, metals & mining, and energy led the way, with each group gaining about 2%. The weakest relative performers were cable & satellite and broadcasting, with each declining about 3%. From a credit-rating perspective, returns were comparable among debt rated BB and B, and both categories outpaced lower-quality bonds.
What factors had the biggest influence on the fund’s relative performance?
Security selection in cable & satellite, technology, and utilities added the most value on a relative basis. On the downside, a greater-than-benchmark allocation in broadcasting, along with picks in services, dampened performance versus the benchmark.
What is the team’s near-term outlook?
We have a positive outlook for high-yield market fundamentals and the overall supply-and-demand backdrop. Our view on valuations is more neutral, given the relative tightness of yield spreads in the market as of year-end. [Spreads are the yield advantage high-yield corporate bonds offer over comparable-maturity U.S. Treasuries.]
Our positive fundamental outlook is underpinned by the ongoing distribution of Covid-19 vaccines. That said, we continue to closely monitor issuers’ balance sheets and liquidity metrics, with an eye toward default risk or a credit-rating downgrade.
As of period-end, U.S. economic growth expectations had moderated somewhat. However, we believe U.S. gross domestic product will continue to grow at a rate above the longer-term trend in 2022. Following robust corporate earnings growth in 2021, market expectations for 2022 were adjusted down to the low double-digit range. Despite decelerating economic and corporate profit growth, credit metrics and ratings continued to improve for high-yield issuers, in our view. Moreover, we believe issuers continued to benefit from strong demand for credit risk.
All these factors resulted in a very low default rate. Including distressed exchanges, the U.S. high-yield default rate ended the year at a record-low 0.29%, well below the long-term average of 3% to 3.5%, and down from nearly 7% at the beginning of the year.
We believe the high-yield bond and leveraged loan default rates will remain well below average for at least the next two years, and maybe longer. The most obvious catalyst for low default rates is the robust growth backdrop and rapid improvement in credit fundamentals forecasted for the coming year. We believe debt, which is currently more than five times greater than equity, on average, is likely to drop to below four times by the end of 2022. Additionally, average revenues and earnings are already above pre-pandemic levels. Another dynamic supporting low default rates is the wide-open access to capital markets. Record bond and loan refinancing activity totaling $1 trillion in 2020 and 2021 has improved corporate liquidity. And in that context, we expect capital markets to remain highly accessible in 2022.
As for supply/demand dynamics, new issuance of high-yield debt totaled $483 billion in 2021, an 8% increase over 2020. About 60% of 2021’s new issuance was used to refinance existing debt. On the demand side, high-yield funds [mutual funds and exchange-traded funds] experienced outflows of $13.6 billion in 2021 compared with inflows of $44.3 billion in 2020. However, the asset class experienced five consecutive months of inflows from August through December 2021. Despite the mixed outcome for fund flows, demand from institutional investors for newly issued bonds supports our positive view of market technicals.
From a valuation standpoint, the average spread of the fund’s benchmark tightened to 3.75 percentage points over U.S. Treasuries during 2021, significantly below the long-term average of 6 percentage points. The benchmark’s yield was at 4.7% as of December 31, close to a record low. Despite tight spreads and lower yields, we think the market’s income potential remains attractive in the face of much lower global yields.
How was the fund positioned as of December 31?
Relative to the benchmark, the portfolio had overweight exposure to the higher- and lower-quality areas of the market and an underweight allocation in mid-tier bonds. From an industry perspective, we favored industrials, energy, health care, diversified media, and chemicals. The fund had underweight exposure to food & beverages; retail; gaming, lodging & leisure; automotive; and services.
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