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Today's U.S. corporate high yield market is worth over $2.5 trillion. That's more than the stock market capitalization of most countries including Germany, France, and Canada. Over 350 funds provide exposure to U.S. high yield including mutual funds, ETFs, and closed-end funds. In addition, a growing number of alternative funds such as distressed debt, mezzanine finance, and credit hedge funds also generate returns from high yield debt. High yield debt has never before been so accessible to both institutional and individual investors around the globe.

The attraction to high yield stems from its high risk-adjusted returns over time. High yield can be broken down into two market segments: high yield bonds and leveraged loans. Over the past 20 years, high yield bonds have produced high single-digit total returns comparable to the S&P 500 with less than half the annualized volatility.1 Leveraged loans have posted mid-single-digit returns with lower volatility than bonds and only one negative total return year in two decades.2 This performance is why pension funds, endowments, insurance companies, institutions, and retirees increasingly buy high yield as a source of current income and complement to dividend paying stocks.

Yet, despite its size and significance, high yield is an often misunderstood asset class. It's a market that is primarily traded over-the-counter and lacks transparency. It has also grown in complexity since its early “junk bond” days. What market professionals come to learn is that not all high yield exposure is the same: specific market segments and fund types can produce meaningfully different results over the same time period. Developing a more informed view of the market is what can lead to a performance advantage.

Working at leading investment firms has provided me with a front row seat to the latest developments in the high yield market during its most transformative period of growth. My first job out of college was in the investment banking program at J.P. Morgan & Co. I joined their high yield group at a time when the firm was pioneering the use of credit default swaps, a trillion dollar industry today. I later joined Goldman Sachs & Co., where I worked on a multi-billion dollar mezzanine fund that was a pioneer in making large-sized privately structured high yield debt investments. Following Goldman Sachs, I spent eight years at Apollo Investment Management where I was a Partner and Investment Committee member responsible for investments in all types of high yield debt through a business development company. More recently, I established a credit hedge fund with the backing of a prominent family office. This fund is engaged in both long and short investment strategies related to high yield bonds and loans and is a top performing high yield fund at the time of writing.3

In my career, which spans nearly two decades and two recessions, I have been fortunate to learn from some of the smartest people in the business. I have worked with teams to invest billions of dollars in high yield issuers. I've seen periods of economic growth and decline, high and low volatility, and have restructured companies that failed to perform. This experience has afforded me with numerous insights on the high yield market which I share in this book.

The decision to write High Yield Debt: An Insider's Guide to the Marketplace was made almost two years ago. While fundraising, I met with many individuals responsible for high yield investments who had surprisingly little understanding of the market. Rather than go through my pitch, I would take these groups through a primer I developed, addressing everything from the high yield market's evolution to tracking the health of issuers and value in spreads. Seeing the knowledge gaps even at the Chief Investment Officer level made me realize that there is a broad-based need for better information on the high yield market. Put another way, if the people managing large investment funds have difficulty understanding high yield, what does that mean for everyone else?

There is surprisingly little literature on the high yield market despite its market size and importance to the economy. In the early 1990s, several books on high yield were released that provided information on junk bonds but the market was very different then. It was one one-tenth its current size with less complexity and it did not include a large, traded leveraged loan market as it does today. Recent books on high yield are more specialized and written for the analyst seeking job skills or the fund manager contemplating more advanced topics related to risk management. What is missing is a book for everyone else – which actually encompasses most market participants.

Within the high yield industry, comparatively few people partake at the level of making buy-sell decisions on individual debt instruments. This is because high yield bonds and loans are difficult to transact in small quantities. Most wealth allocators are engaged at a level where they are deciding whether to buy into a high yield fund and, if so, which one? Other professionals, like market analysts and bankers, provide services related to the industry and are seeking a better understanding of the bigger picture. Participants like private equity firms, lawyers, and issuers need to know the financial and legal terms of high yield debt. Business school students and analysts in training programs can gain an advantage with interviews and a head start on the job with a more informed perspective of high yield capital markets and investment banking.

My goal in writing High Yield Debt: An Insider's Guide to the Marketplace is to explain the U.S. corporate high yield market in basic terms and as concisely as possible. This book will address how the market has evolved, who buys and issues high yield, high yield debt structures, asset class performance, and how to track and evaluate the market for investment opportunities in a variety of different funds. In writing this book, I make no assumptions about the audience's knowledge level; I assume that most industry jargon is confusing and requires explanation and I get into a fairly deep level of insight and analysis such that even experienced market professionals will find something new and interesting. I also seek to explain the most frequently asked questions I've received on high yield. Last, I include what I consider the most important historical market data so that this book can be referred back to over time on any areas of interest.

BEFORE YOU BEGIN

This book can be read either cover to cover, or consulted when topics of interest surface. The Contents outlines the book's progression. It lists key topics of common interest for easy reference. Many of these topics are questions I have been asked during investor meetings. Any potentially confusing terms are italicized and included in the Glossary. Each chapter contains an introduction and summary with key insights, which is relevant to subsequent chapters. While this can be kept as a reference book, I recommend at least skimming chapter summaries from start to finish to gain a better sense of the book's contents.

Chapter 1 starts with an introduction to high yield, beginning with a basic definition of high yield debt and progressing to how the high yield industry evolved from a market for fallen angles to a thriving $2.5 trillion industry. Chapter 2 delves into the issuers of high yield – explaining why they raise high yield debt, the decisions they face, and the capital-raising process with investment banks. Chapter 3 then addresses buying high yield, and provides insight on important differences in the buyer base and financing for high yield bonds and leveraged loans. I also address the implications of high yield being an over-the-counter market and trends with liquidity, a common concern. Chapter 4 addresses financial concepts and economic terms important to understanding high yield debt, which is vital to assessing and tracking the market.

Chapters 5 and 6 round out the foundational knowledge required to form a view on high investment opportunities. Chapter 5 addresses high yield debt structures and how these differ for high yield bonds and leveraged loans. Understanding what constitutes aggressive versus less aggressive debt structures also provides a means to track developing trends in the marketplace. Chapter 6 provides an overview of high yield credit agreements, a more technical topic, and also discusses other legal considerations such as recent regulatory developments, which are topics particularly important to credit investors, high yield issuers, and corporate lawyers. The purpose of Chapter 6 is to explain what protections exist in high yield credit agreements and clarify the meanings of certain industry jargon that is often used but frequently misunderstood.

After establishing a framework for understanding the high yield industry and the differences between its two key market segments – high yield bonds and leveraged loans – Chapter 7 gets into a topic of great interest: asset class performance. Chapter 7 addresses many frequently asked questions on high yield performance such as total returns, volatility, interest rate risk, defaults, and recovery. Building on this foundation, Chapter 8 provides a few tools and metrics that can be used to assess the market opportunity at a given time. This evaluation method includes incorporating a view of corporate spreads with industry fundamentals to provide a sense of the risk-reward for both leveraged loans and bonds. I also provide a list of the information sources used by high yield investors to make more informed decisions. Armed with this knowledge, the reader is better able to form and express a view on the various investment options, which for most investors are funds rather than individual debt instruments.

Chapter 9 describes the different “public” or 1940 Act funds that provide high yield exposure such as mutual funds, closed-end funds, ETFs, and BDCs. The different 1940 Act Funds have pros and cons which also vary depending on the type of exposure sought. I explain the primary considerations related to each of these fund options and discuss their performance over different periods of time. Chapter 10 addresses “private” or alternative funds that provide high yield exposure such as mezzanine funds, credit hedge funds, and distressed funds. Private funds are generally only available to larger investors that meet certain income and net worth requirements. These types of funds have higher fee structures but can outperform in certain market environments primarily through the use of fund leverage, active investment strategies, and greater portfolio concentration. Understanding the conditions under which these funds can thrive can be helpful when choosing which one to pursue.

CONTACT

I am grateful for your interest in this book and would welcome any questions or comments you have. Please feel to reach me at rajaybagaria@hydebt.com or visit the website www.hydebt.com for more information.

DISCLAIMER

The concepts and ideas in this book are my own and other professionals may disagree with my conclusions. There are risks involved with investing, including the possible loss of capital. Investors should consider the investment objectives, risks, charges, and expenses of the fund(s) carefully before investing. Please seek the counsel of your accountant for any tax-related matters as there is no tax guidance presented in this book.