With U.S. high yield markets starting from solid ground, our approach to managing trade risk is to limit unnecessary exposure to affected industries.
Trump’s policies around taxes, regulations, tariffs, and government reform were well communicated during his campaign. Less clear was the sequence, pace, and magnitude of policy implementation. Tariffs and government reform became the main agenda items in the first quarter, creating a high level of uncertainty in the markets. The April 2 announcement on what the administration describes as reciprocal tariffs was much greater than market expectations, resulting in a significant sell off. Consequently, most strategists reduced estimates for earnings and economic growth and increased estimates for inflation. In addition, stagflation and recession risks jumped and rate cut expectations rose.
We believe the high yield market is generally in a good position to withstand an economic slowdown. Credit fundamentals are stable, near-term refinancing obligations remain low, and management teams continue to exercise balance sheet discipline. In this environment the default rate should continue to stay below the historical average of 3-4%.
That said, most sectors have been impacted by the tariff news. Companies with offshore production, higher overseas sales, lower margins, and less pricing power are generally worse off than companies with domestic production, higher domestic sales, higher margins, pricing power, and market share. Along those lines, the U.S. high yield market tends to be more domestically aligned.
From a positioning standpoint, the goal is to limit exposure to the most impacted industries. Here’s where the Voya Short Duration High Income portfolio stands and some recent activity:
- Auto manufacturing exposure (investment-grade rated) is negligible. Auto parts and auto sales exposure is via automotive retail as well as collision center operations.
- More traditional retail is limited to a luxury clothing company.
- With respect to materials, the portfolio’s aluminum manufacturing and chemical production exposure is minimal at <1% and, arguably, offset by steel exposure (~1%), which could be a tariff beneficiary.
- Aside from seeking to limit exposure to the most tariff sensitive sectors, the portfolio has avoided exploration & production – a subindustry impacted by oil price volatility.
- In addition, more recent fund purchases include broadcasting and cable & satellite TV – industries with low perceived tariff risk – as well as mortgage finance, which could also benefit from lower interest rates.
We continue to monitor the situation and portfolio closely, with a focus on avoiding economically sensitive businesses with deteriorating credit outlooks in favor of companies with stable operating and earnings visibility.
A note about risk: Debt instruments: Debt instruments are subject to greater levels of credit and liquidity risk, may be speculative, and may decline in value due to changes in interest rates or an issuer’s or counterparty’s deterioration or default. High yield fixed income securities: There is a greater risk of issuer default, less liquidity, and increased price volatility related to high yield securities than investment grade securities. Market volatility: The value of the securities in the portfolio may go up or down in response to the prospects of individual companies and/or general economic conditions. Price changes may be short or long term. Local, regional or global events such as war, acts of terrorism, the spread of infectious illness or other public health issues, recessions, or other events could have a significant impact on the portfolio and its investments, including hampering the ability of the portfolio’s manager(s) to invest the portfolio’s assets as intended. Issuer risk: The portfolio will be affected by factors specific to the issuers of securities and other instruments in which the portfolio invests, including actual or perceived changes in the financial condition or business prospects of such issuers. Interest rate risk: The values of debt instruments may rise or fall in response to changes in interest rates, and this risk may be enhanced for securities with longer maturities. Credit risk: If the issuer of a debt instrument fails to pay interest or principal in a timely manner, or negative perceptions exist in the market of the issuer’s ability to make such payments, the price of the security may decline.