Capital Ideas^TM

With yields at historic levels in high yield and emerging market debt, seasoned portfolio manager Rob Neithart discusses how he is approaching the key risks and opportunities in markets today. He also explains the process behind Capital Group Global High Income Opportunities (LUX)’s (GHIO) new carbon footprint target.

What do you see as the key risks and opportunities in markets today?

Looking at on-the-ground activity, corporate profits have been strong and most measures of economic activity have been improving. However, the key risk is how the real economy responds to tighter financial conditions.

The US Federal Reserve (Fed), European Central Bank and other global central banks are tightening policy in response to higher inflation. These measures will inevitably cause a slowdown, but it remains unclear whether this pushes economies into recession, or we see a stabilisation at higher interest rates and lower growth.

The market is forward looking and has already significantly discounted these future risks. This is where opportunities may arise. Yields have re-set to very high levels. This means much of the aggressive central bank tightening and risks around economic activity have been priced into current valuations.

Across the emerging markets (EM) universe yields are between approximately 7% to 8%. For high yield (HY), the range is between 8% and 9%, depending on credit rating and sector. So there is potentially a lot of yield cushion to compensate for the risk level. History indicates that yields at these levels could lead to very strong total returns over three-to-five years.

How would you frame GHIO’s prospects in the current environment?

The yields I refer to above are some of the highest we have experienced in a long time in both high yield and emerging markets. At these yield levels, the forward-looking returns appear very attractive using the past 25 to 30 years as a guide.

While there is significant geopolitical and economic uncertainty globally, these concerns have been reflected in the negative total returns generated this year across all asset classes.

The advantage of a yield-oriented portfolio is the income generated can help offset further volatility. Currently, Capital Group Global High Income Opportunities (LUX) yields approximately 7.8%¹. This represents a high level of income generation potential and is a strong starting point to achieve solid returns over a multi-year timeframe. However, the longer term time horizon is key; investors need to have patience to ride through the bumps.

The portfolio invests broadly across emerging markets and high yield. What is your current thinking regarding relative value between EM and HY?

We currently prefer emerging markets on valuation grounds. Our valuation models flag a significant divergence between HY and EM, with EM significantly cheaper on both a hard and local currency basis. Some of that valuation premium is justified because of more fragile economies and riskier credit profiles within the EM universe, and particularly for markets more directly impacted by the Russia-Ukraine conflict. However, the magnitude of the discount is approaching historical extremes.

1. As at 31 May 2022. Based on yield-to-worst. Sources: Factset, Capital Group

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.