Dislocations Occurring in Parts of the Credit Markets

For thefirst time ever, the yield on junk bonds has fallen below the yield on loans that rank higher up in the capital structure, signaling that the demand for riskier debt continues unabated. The 5% yield on junk bonds compares to 5.5% on leveraged loans, which would be paid out first in a workout scenario. This reach for yield is occurring in the investment grade market as well, with credit spreads on high-grade issuers at the lowest level since 2007. While it is true that balance sheets have improved and companies are less reliant on short-term means of financing such as commercial paper, overall leverage (debt relative to cash flows) is ticking up. As we look for credit opportunities in this market, we are looking for corporations that have a catalyst behind them, such as growing industry or a recent acquisition that will drive future growth. In markets that show signs of froth, we believe that picking the right bonds will lead to outperformance.