Weekly ETF Brief

Is Trump a Green Light for Convertibles and US High Yield?

The Trump election victory has been so far much more supportive for equities than for bonds. The prevailing risk-on mood suggests sticking with strategies that should benefit from a soft landing and a gradual reduction in rates — such as high yield and convertible bonds.

18. November 2024 5 min read

Jason Simpson

Senior Fixed Income ETF Strategist

US High Yield Continues to Gain

Donald Trump’s US election victory has proved very .supportive of equities, in particular, small and mid-cap exposures – and we have already outlined the upside implications for equity sectors.

The Republican win is less obviously positive for bonds and the underlying Treasury curve has bear-steepened since the election. Yields have edged back lower but increased fears over inflation and the degree to which the Federal Reserve will be able to cut rates has been another set-back for the long duration trade. In contrast, risk-on fixed income strategies, such as high yield, fared rather better. US high yield could enjoy a 9th successive quarter of positive gains¹, if the sector holds or builds on its election gains into the end of the year.

Credit spreads have dramatically narrowed post-election, but this looks less of a risk in the context of the economic and investment backdrop:

The post-election risk-on mood has been driven by higher levels of conviction that growth will persist with the political agenda being viewed as more pro-business.
Spreads are tight but, as we explore in the Global High Yield Update – Q3 2024, the fundamentals for non-investment grade issuers still look positive. Earnings have been strong, default rates relatively low for this stage of the economic cycle, and rising stars have outpaced fallen angels.
The decline in yields coupled with tight spreads have seen financing conditions for non-investment grade issuers improve. A good amount of the much feared ‘2025 refinancing wall’ has been successfully re-financed. Figure 1 shows the redemption profile in par value terms of the Bloomberg US Corporate High Yield index amount on 31 October 2024 versus December 2023. A large proportion of 2025 maturity bonds and some 2026 bonds have been refinanced.
Yields remain at interesting levels, above 7% for the Bloomberg US Corporate High Yield index, against a 10-year average of 6.6%. Yields are a key determinant of total returns and it is worth noting that only once in the last 10 years would an investor have suffered a negative return over 12-months had they invested in high yield that was yielding 7% or more².

Convertible Bonds Ride the Equity Wave

Convertible bonds are an alternative for investors who are reluctant to significantly allocate to non-investment grade credit at such a late stage of the economic cycle. These have performed well since the start of November, are similar in that they have a short duration and are well correlated to small cap equity exposures³. However, the ratings profile is typically crossover, with the split for the SPDR® Refinitiv Global Convertible Bond UCITS ETF being over 58% in investment grade rated paper⁴.

Convertible bonds should continue to perform in a soft landing scenario with gradually declining rates. Central bank policy easing, and buoyant equity markets would support both the bond and equity components of the asset. There are also other diversification benefits, notably the index is weighted towards the Technology sector (around 25%) which has proved a key growth engine for equities in general. However, around 58% of the fund is in small and mid-cap issuers, and the names in the Refinitiv Qualified Global Convertible Index are not Big Tech, which are generally perceived to be over-bought.

The index delta — its price sensitivity to the underlying equity — is close to 46, broadly in line with the long-term average⁵. History suggests average returns of around 7% over the following 12-months using a delta of 46 as an entry point⁶. So further equity market gains should support returns and as we point out in Convex— and Ahead of the Curve there is an asymmetry to convertible bond returns. These have tended to capture on average between 45% to 60% of the upside performance of underlying equities, but the bond floor has resulted in a lower participation to the downside which averages 35% to 50%.

Footnotes

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