AXA WF US High Yield Bonds

December’s economic assessments suggested a degree of stabilization rather than confirmation of further deceleration in overall activity. Unsurprisingly the manufacturing sector remained stagnant, however the return of striking auto workers did abruptly reverse some of the previous months’ downturns. And, as expected, the nation’s service sector continued to provide most of the current economic momentum, thereby propelling further gains in employment, income and spending, without generating any discernable upward movement in the most widely followed inflation metrics. The ICE B of A Merrill Lynch U.S. High Yield Index posted a total return of +2.09% in December, making it the third highest monthly return of 2019. High yield bond yields declined as investor demand for risk-assets increased throughout the month, following a phase-one trade agreement between the US and China. The high yield market saw modest inflows (approximately $1.6 billion) during the month, thereby bringing full year net inflows to a total of $19.5 billion. Gross high yield new-issue activity declined modestly during December, dipping below the monthly average new-issue volume for full-year 2019 ($23.9 billion). Specifically, 32 bonds priced totaling $19.6 billion, as compared to $37 billion priced in November. New issue volume was strong compared to the same month last year, given no companies chose to issue debt in the high yield market during December 2018. Full year 2019 new issue volume of $286.6 billion is 53% higher than the $187.4 billion of issuance during the prior year. There was one high yield bond default in December totaling $300 million, and no distressed exchanges. The par-weighted default rate was 2.63% at the end of December, down marginally from 2.65% last month. During December, U.S. High Yield underperformed U.S. Equities (S&P 500 +3.02%), but outperformed U.S. Corporates (+0.32%) and U.S. Treasuries (-0.62%). Within U.S. High Yield, triple C and lower-rated credits (+5.65%) outperformed both single B-rated (+2.10%) and BB-rated credits (+1.25%). From a sector perspective, all the 18 sectors in the index posted positive monthly returns. The best performing sectors were Energy (+5.62%), Insurance (+2.82%), and Automotive (+2.23%). On a relative basis, the worst performing sectors were Real Estate (+0.39%), Financial Services (+0.77%), and Leisure (+0.86%). The High Yield Index’s Option Adjusted Spread was 360 basis points at the end of December, 42 basis points tighter for the month. The High Yield Index’s yield-to-worst ended the month at 5.41%, which declined 43 basis points from the start of the month (5.84%). Finally, the High Yield Index’s average price was $100.74 at month end, $1.68 higher than the $99.08 average price at the start of the month. AXA IM’s core unconstrained US high yield strategy slightly underperformed the broader high yield market during the month of December, capturing over 85% of the market’s return. An overweight to the short duration portion of the market was the biggest driver of underperformance. The strategy also experienced negative security selection within the highest yielding portion of the market, as the more distressed capital structures outperformed. An underweight to the higher quality portion of the market helped with relative performance. Finally, several larger positions in the strategy, each yielding slightly higher than the market yield, helped relative performance by producing very strong returns during the month. The strategy participated in only a handful of new issues in a quiet primary market. From a sector perspective, negative security selection within the Energy sector was the primary driver of the underperformance. The up-in-quality positioning within this sector, which generated alpha through the first 11 months of 2019, gave back some of that alpha generation in December as the most stressed Energy credits outperformed. The strategy produced positive security selection in the Retail sector, led by a rebound in bonds of Shutterfly, as the company reported satisfactory results and provided a fairly upbeat guidance. The strategy also experienced positive security selection in the Telecommunications sector, as bonds of Cincinnati Bell Inc. rose higher after it was announced that the company was being acquired by Brookfield Infrastructure. Our flagship fund finished the month with a yield-to-worst of 4.92% (exclusive of cash) compared to the benchmark yield-to-worst of 5.41%. The duration-to-worst remained at 2.1, lower than the benchmark duration of 3.0. We continue to maintain less duration than the benchmark, despite this being a significant source of our underperformance in 2019. We remain underweight double B securities with longer maturities, as the poor convexity of many of these securities make it an unattractive investment at this time. We will maintain an overweight position to the short duration segment of the market until we see some weakness or repricing of the overall high yield market. We believe the yield advantage between higher yielding securities and higher quality securities is attractive, justifying a market weight or greater positioning to higher yielding securities. However, we remain very selective when investing in this portion of the market. Unquestionably it will be policy guidance from the Federal Reserve that will act as the touchstone from which to gauge the relative importance of upcoming economic data in the coming months. With that said, the potential for winter weather and faulty seasonal adjustment factors to support a narrative that the US economy is faltering is a distinct possibility. As such, monitoring shifts in both business and consumer confidence may offer some insight to either confirm or challenge that the currently in place trends of strength in consumer consumption and weakness in manufacturing remain the operative scenario in the opening months of the new year.