Short dated high yield: The importance of excess spread | Insight Investment

Yields have dropped but remain high

After a seismic upward shift in yields over recent years, high yield markets rallied into the end of 2023 but yields remained well above the levels seen in recent years.

A driver has been a normalisation of market spreads, which have tightened to levels seen a few years ago.

When looking at high yield investments, excess spreads are a more important metric than market spreads.

The excess spread is the market spread, deducting an expected level of defaults.

As we analyse companies, our aim is to accurately forecast cashflows for the companies we invest in over our two-year investment horizon. If a company reports a deviation from what we’re expecting, then we sell the position. This provides us with confidence that over time our defaults should be close to zero.

Given our approach to avoiding defaults, we would expect Insight’s global short-dated high yield bond strategy to have a level of defaults well below the market in aggregate.

If we achieve our zero-default target, our market spread and excess spread will be the same. In effect, this means the excess spread of the strategy was around 140bp above the excess spread of the euro high yield market at the end of 2023.

Insight’s global short-dated high yield strategy seeks an excess spread well above market levels

Source: Insight and Bloomberg. Data sourced from JP Morgan, assumes 150bp loss rate in 2023.