High Yield: Tariffs, Tensions & Tactical Shifts

Greg Campion: High- yield bonds and senior secured loans have continued to garner significant investor interest in recent months, in no small part because of the attractive yields on offer. The question is, can high- yield strength continue against a backdrop of relatively tight credit spreads, tariff uncertainty and the potential for an economic slowdown?

Scott Roth: The market wants to look past the tariff issue. They have looked past the tariff issue here, and what they see is the prospect for deregulation potential rate cuts, some stimulus associated with the tax bill. All of these components can really help sterilize this tariff issue.

Greg Campion: That was Scott Roth, head of Global High- Yield at Barings, and this is Streaming Income, a podcast from Barings. I'm your host, Greg Campion. Coming up on the show, investing in high- yield in a world of tariffs, economic uncertainty, and a quickly shifting landscape. Before we get into the conversation, remember you can follow Streaming Income on Apple Podcasts, Spotify, and if you'd like to watch the full video episodes on YouTube as well. Finally, make sure you're following Barings on LinkedIn, so you'll be the first to receive our soon- to- be- launched newsletter where credit is due, where we'll be spotlighting people and portfolios in asset classes from high- yield to private credit and everything in between. With that, please enjoy this conversation with Scott Roth. All right, Scott Roth, welcome back to the podcast.

Scott Roth: Great to be here. Thanks for having me, Greg.

Greg Campion: Yeah, excited to have you here. Excited to talk about high- yield. So much going on and probably a hard time to draw a lot of concrete conclusions today, but I want to get into all of it. But maybe before we do, for listeners who maybe don't know you haven't heard our prior episodes, just tell me a little bit about your role here at Barings, the team you manage, and maybe just a little bit about your background.

Scott Roth: I run the global high- yield business. I really partner alongside Adrian Butler who runs the side- by- side, the CLO and structured credit business, but it's a ninety- plus- billion- dollar platform. It's one of the largest public leverage finance businesses globally. And look, I've worn a lot of hats. I've been in Barings for quite some time, since 2002. Started out as an analyst, followed a lot of different sectors over time, migrated into the portfolio management ranks and over time assumed some level of management roles.

Greg Campion: Yeah, it's a great team. It's probably one of the best- known teams here at Barings. We talk about a high- yield all the time on this podcast and it's great to be able to interact with you and your team so much. I feel like you're really the center of the action in a lot of these asset classes. So let's dive into it. I would thought maybe we would start high level but also very topical and timely. Obviously, we're all getting absolutely pummeled right now with headlines around tariffs in particular, debates around how much of it is really impactful, how much of it is just noise and rhetoric. But we are seeing, I'd say for a lot of this year we've seen a lot of these headlines around the Sell America trade. So it'd be interesting to hear your thoughts around that, and this concept that is the period of, quote- unquote, US exceptionalism over. So let me just ask you, thinking about all of that broadly and then going down to the level of the high yield market, I'm curious how much of it is actually impacting your markets and maybe how much does it impact how you and the team are actually making allocation decisions across global portfolios?

Scott Roth: This narrative around the end of American exceptionalism, really it's taken somewhat of a pause here as markets have basically retraced their April lows, and have actually gone on to reclaim new highs across credit and equity markets. So the discussion around this topic, quite frankly seemed maybe a bit premature. I think I still see US is center of growth, center of innovation. You have mega cap tech companies that are really still in the league of their own. And just more broadly, US markets, the depth and breadth of those markets are unmatched. We've been having discussions with our investors, a lot of which sit outside of the US borders. And look, they've voiced their concerns, we hear those concerns. I think as they look at alternatives, I think they've come to the realization that in certain markets right now there just is not a viable alternative in many cases. Look, I think we have to acknowledge that there were some real correlations that broke down in April. The US clearly, their fiscal trajectory is unsustainable and we know a lot of those... Some of that federal spending, those programs were born out of COVID and really continued in the post COVID era. But the US does have a spending problem. They really don't have a revenue problem. But the problem really lies. We've seen some recent initiatives around reduced spending spending cuts, and those have been met with a lot of resistance. So the US is in a position where it needs to be able to find a way to grow outside of some of the fiscal issues. And I think that's going to be challenging. Ultimately, if the US is not able to find its way out of its fiscal problems, the markets are ultimately going to be the arbiter here. And I don't know, when that threshold is crossed. I don't think anybody knows when that threshold is crossed or at what point in time that looks like. I guess just bringing it back to the markets I'm involved in day- to- day and that being high yield, I think it's always a good opportunity to maybe just step back and look at the opportunity set that that's in front of you and not to have blinders on. I know a lot of investors, high yield investors in our space are very concentrated on they will only invest in US loans or bonds. And that may be somewhat short- sighted. When you look at some of the opportunities that exist in let's say Europe, where that market has some real diversification benefits, it's a market that higher quality in terms of ratings, historically has offered more spread. And not to mention it's actually outperformed the US in 11 of the past 15 years. So it can be a very nice complement to a US strategy, so more of a global strategy in a sense. Even on the equity side, I talked to our equity colleagues and we know that global equity investors are way over- indexed to US equities. And our equity team will tell you they are finding very good opportunities in a variety of international markets where they see fairly solid valuations. If we think about the US dollar and there's a lot of talk about the US dollar in structural decline, that could open up the opportunity on the emerging market side as well. But just as I said, we've had some discussions with our investor base. We haven't seen anything manifest itself in terms of flow activity. As we talk to the street, we have teams internally here as well that track this stuff. And really we haven't seen any type of flow activity materially change. And so, I just view this again as a good time to step back, reassess, look at your exposure and just make sure you're comfortable with your existing positioning.

Greg Campion: Yeah, I think that's the million- dollar question or maybe it's the trillion- dollar question is when does this deficit end up really biting or when does it really matter? And I don't know, you could argue, I think that in some ways you're starting to see that manifest. One of the ways that you mentioned, dollar weakness, talk of yet is are we seeing structural weakness, it's already devalued a good bit this year. Does that continue? And if so, does that become a catalyst for people to get more interested in some of the more global exposure?

Scott Roth: Some of these concerns are manifesting themselves in the long end of the curve you're looking at. And it's not just the US. We're seeing long end yields, 30 year yields really begin to break out. So the curves are steepening. And look, the fiscal situation, US is not alone in terms of running deficits. And so, again, the breaking point, who knows what that looks like? So the question is can the US break out and exhibit some level of growth? But the markets at the end of the day are going to dictate this. But look, there's opportunities out there and again, it's not being dialed into just a US strategy. And we have a global platform. We look at a lot of markets both credits and equities, and sometimes you just have to get below the surface and you can find really good value that exists in markets outside the US.

Greg Campion: Yep, that's great. Great point. Really more idiosyncratic opportunities as well. So all right, let's talk a little bit about what's going on just in terms of the economy. A lot of talk about will we see a recession, won't we see a recession? It seems like things are okay, chugging along. Talk about interest rate cuts at the end of the year. Will that manifest, yes or no? Who knows? Still remains to be seen. Probably a function of if Powell stays in his job or not. But then you get into the conversation of shadow, fed chairs and all that stuff and what the market starts pricing in. But let's talk about your views on I guess the fundamental picture. I think some of the discussions we've had internally recently have been talking about a bit of a bifurcation that we're seeing, is you mentioned some of these large mega tech companies, and we're seeing these massive CapEx programs out of them. So things seem to be chugging along pretty well for at least part of corporate America. Then arguably you've got a consumer at least at the lower end of the income brackets that may be struggling a bit and showing signs of weakness. So you guys have your ear to the ground. You have such a great perspective on all of these companies across the economy. I wonder when you're talking to all the analysts across all these sectors on your team, what are they seeing in terms of corporate fundamentals and maybe how's your outlook there changed over the course of the year?

Scott Roth: Well, well look, I would characterize corporate fundamentals as stable to improving overall. There is some sector dispersion in terms of how this recovery has played out since the earnings recession. Not an economic recession, an earnings recession that I would characterize as lasting from fourth quarter of 2022 through the first part of 2024. And that unevenness in the economy has really been focused in areas that have been more interest rate sensitive such as home builders, automotive, where volumes have really been anemic, and those are sectors that are not inherently large within high yield, but there are some downstream impacts into building materials, chemicals, where volumes have basically been flatlining here, going sideways, really awaiting a broader global recovery, or you need lower interest rates to solve for that affordability issue that exists. On the other side of the ledger, you have a number of different sectors that are actually doing quite well. Technology, which we've talked about a little bit. Industrials, healthcare, even consumer discretionary. And within consumer discretionary, it highlights something like cruise lines, which that was a business model that was really caught in the crosshairs of COVID. These were investment grade rated companies. The business model came under a lot of pressure. They were downgraded to high yield. Subsequently, we've seen demand, robust demand recovery here that has really changed the trajectory of their businesses, and they're really on a glide path back to investment grade. I guess to your point on the tariffs and maybe the interplay that we're seeing with inflation and rates, our framework really hasn't changed for the most part over the last couple of months. There's a lot of wood to chop still with the tariff issue. You probably won't see the biggest impact until the third quarter and potentially into the fourth quarter here. But as we talk to our portfolio companies, what we hear a lot of is that they plan on pushing prices through. I would say a lot of that confidence resides in the fact that they've been very accustomed in terms of their being effective in their pricing strategy over the last four years. However, the environment's changed a little bit as well, and there are some cracks that exist in the economy but still on stable footing. But I would say the consumer is probably not as flush as they have been. So you might find yourself in a situation where some of the costs are passed through and some of the costs ultimately have to be absorbed by the company. And so, that will impact margins to a degree. But I would say as we take this all in, I think our view is that the tariff issue, the broader economy will be able to absorb the tariff issue. There's still a lot of noise around tariffs. A lot of market participants really feel investors are complacent around this issue. I would just say investors seemingly are more in a wait and see mode and are not reacting to every headline that is-

Greg Campion: Desensitized a little bit to rhetoric and maybe focused a little bit more on what actually gets implemented.

Scott Roth: Yeah. And I think there's been a precedent that the administration has set. they've seen that and how the administration will ultimately react. And look, the market wants to look past the tariff issue. They have looked past the tariff issue here. And what they see is the prospect for deregulation, potential rate cuts, some stimulus associated with the tax bill. All of these components can really help sterilize this tariff issue.

Greg Campion: All right, so let's think about how you're considering where there are pockets of value or where there is good value in high yield or in the loan market today against this whole backdrop. I think we haven't really talked much about it, but credit spreads are at the tighter end of historical ranges. I think some people are wondering, is there value here? Is there not value here? How are you thinking about that broadly in terms of if investors are being adequately compensated for the risks they're taking today and below investment grade markets?

Scott Roth: Well, there has really been a change in terms of how investors are looking at credit over the past few years. High yield has become an all in yield product. There has been this debate that's been waged. As you point out, spreads are on the tighter side today. But that debate, yield versus spread, and I think the answer has really fallen on the side of yield buyers in today's market. They have won that pretty decisively. We still get questioned and pressed on spreads, so that's not surprising to hear that. But Howard Marks has a great quip that I've heard him reference more than once that investors can't eat spreads. And we would agree with that assessment and I would just maybe make some observations as it relates to high yield markets and valuations. I think, and I've been on your program before and I've talked about this, but the composition of the market matters.

Greg Campion: Sure.

Scott Roth: And today's market's much higher quality in terms of ratings than it has been in past periods. Double Bs make up the vast majority, call it 50% of the market, whereas they were 30% years ago. Triple C's, again, much lower than they have been in prior periods. So it's important when investors start referencing historical spreads that they're not comparing apples and oranges at the end of the day. And look, the high- yield market, the businesses they're financing today are different. They're larger today. The amount of LBO financing is a fraction of what has been over time. And I would highlight a couple other factors as you think about valuation. One being the duration of the market today, which is at all- time lows. It's a market that still is at a discount to par. So those two elements right there do provide some level of stabilization and can mitigate some of that downside if you were to have a generic sell off. And then you have to ultimately bring this back to defaults. Where are we at in the default cycle? Because spreads, as you mentioned, that is your default premium. Some investors will also say that's your liquidity premium. But we're in an environment right now where defaults are well below average. They're 1. 5% in high- yield bonds. That's a J. P. Morgan figure I'll throw out, includes distressed exchanges. So it's fully loaded, but that compares very favorably to history, which is run on the order of 3. 5%. So that's not surprising given the composition I just mentioned within the market. Now, you have broadly syndicated loan market. It's run in higher defaults right now, but it's a lower rated market, but it also offers higher spreads, higher yields. But we do think when you factor in where we're at in the economic cycle, we don't expect an uptick in defaults. In fact, in loans, we actually see that compressing closer to the high- yield bond. So I guess bringing this all together, you have a market where you have yields 7 to 8% across high- yield bonds and broadly syndicated loans. We would suggest that you are getting adequately compensated for the risk you're taking. And then when you sense check that against spread levels and forward- looking default expectations, I think you can make a pretty strong case that things are fairly valued.

Greg Campion: And one of the other factors that is really impactful at driving markets, at least in the short term, is market technicals. And this is something that investors don't always have a clear line of sight into. So it'd be interesting to hear you just talk a little bit about what's going on from a market technical standpoint and maybe how that's affecting bonds and loans.

Scott Roth: Right. So market technicals are playing a big role in the markets and they really have for the last few years in terms of supporting trading levels. And again, going back to maybe 2022, when we saw the spike in rates, you saw the corresponding move higher in yields, and that really reset the market, and that drove a lot of enthusiasm for investors that hadn't seen yields at those levels and call it over a decade. And so, that coupled with the demand we've seen out of private credit, the accelerating capital flows, et cetera, it set the stage for really an enormous appetite for credit. And on the other side, you've had supply that has failed to meet expectations. Corporations instead of issuing debt have always been the level of uncertainty around the potential for a recession, whether that was in'22, '23, '24. And so, that curtailed a lot of primary issuance. And M& A has collapsed. We saw that from'22 to'23. It bounced back a little bit in'24, but again, hasn't really met expectations. So it's a market that's been imbalanced with too much demand, not meeting supply. If you think about some of the internals of the market, you've had significant CLO formation. I think as it stands right now, there's nearly 250 warehouses open in the US. And so, that is delivering demand almost on average$15, $ 16 billion a month right now. And if you think about a market where you might have net$ 100 billion of issuance, net new supply that's not refi or repriced, that is just getting eaten up by these coupons. And the coupons are getting larger year after year. And so, there's just not the level of excess to meet this. And so, I think we're probably going to be in this environment for a while. As we look forward in 2026, that well may be the year where you have a lot more M& A activity, you have an administration that is certainly going to be more receptive to M& A. We'll definitely see it on the strategic side. I think it remains to be seen whether you'll see a lot of sponsor activity or at least maybe what the market is expecting, given the fact that multiples are still highly elevated and the cost of financing has come down some recently, but still we're in a bit of a different air from a cost of financing versus the last couple of decades.

Greg Campion: Yeah, super interesting to hear all that. I almost think of it as setting a floor for the market in some ways because you've got this really still strong retail demand. We've seen a lot of flows into ETFs, and I think that goes back to your points earlier just on the yield that's available in the asset class. And then I think when you couple that with the lack of issuance, yeah, you can see a really strong bid in the asset class and then of course the CLO factors as well, so interesting to get your insight into that. I guess one of the other things I just want to ask you about, just because this has been a big trend that we've talked about on this podcast and in other places, is this blurring of lines, right between public and private credit. It's been a big theme, everybody's talking about it. I guess what's not as clear to me as if we look day to day at a market like yours, so we're talking about high yield bonds, we're talking about broadly syndicated loans, where's the rubber meeting the road? Or another way to ask that is, are you actually seeing day- to- day impacts of this big trend and how are you thinking about it overall and how are you thinking about it as it impacts our clients?

Scott Roth: Highly topical, of course. You see headlines daily as it relates to this, almost to the point that you would expect that things are accelerating at a rate that maybe is somewhat inconsistent with what we're seeing really in day- to- day activity. And I would just maybe point to some of the headlines around private credit trading, where there's almost a daily headline around that and what's taking place, what's not taking place. And look at, I think change tends to be accelerated in credit markets. There tends to be certain pivot points during a cycle that really accelerate change when you have large public deals that transition to the private side that are in the billions. It's logical that at some point somebody's going to need liquidity in one of those deals. I suspect that's going to come at a point in time in the future where there's a level of distress in the market and somebody's going to need liquidity. And so, I think there's a lot of positioning around that in terms of when that ultimately begins to transition in forest. But we're really talking about the evolution of the markets and looking at some of these pivot points over time that have accelerated change. I had a front row seat when the broadly syndicated loan market began to take shape, and you had the high yield bond market that was the provider of choice in terms of LBO financing and sponsors were really receptive to public loans and given the flexibility that was inherent in those structures, and we've seen a lot of demand there that ended up.. It was a little bit of a crescendo when the financial crisis occurred, and broadly syndicated loan market pulled back and the high- yield bond market had to reenter into the fray and fill that void. And they did so providing secured financing, secured bond financing. And that really became a sub- component of the high- yield market that really grew. But it grew out of transition in the market. And today that's over 30% of the overall high- yield market. The private credit, the modern era of private credit that we think about didn't exist. That was spawned out of the financial crisis. And so, we'll just fast- forward a little bit, private credit has seen massive capital flows and has grown outside of that traditional middle market framework and is now an alternative to broadly syndicated. And then you had COVID, another pivot point where all of a sudden, broadly syndicated pull back and this time private credit. That was the opportunity for private credit to really make a splash on that front. And that's part of the ebb and flow of credit markets. And it worked out for both asset classes in a way. On the public side, it probably minimized some of the restructurings or defaults that would've occurred. On the private credit side, they were able to deploy a lot of capital and they really took a longer term approach given they're not mark to market, and it worked out for them. And now today, the last couple years, I would characterize our markets as really being in what I would call an equilibrium, just from a volume perspective in terms of what we're seeing, transition from the public side to the private and vice versa, private to public.

Greg Campion: Yep. Well, that's a trend we will keep an eye on because I like the way you describe it as an ebb and a flow. It does feel like that depending on what's going on in the market. And yeah, some of these crisis definitely serving as pivot points. All right, Scott, to finish up here, I want to ask you to step back, put yourself in the shoes of an investor. It could be an institutional investor, it could be a wealth investor, somebody who's got an allocation to below investment grade credit or thinking about it. How would you suggest they think about managing this long- term exposure to the asset class?

Scott Roth: Well, it probably not going to surprise you that I'm proponent of a strategic allocation to either high- yield Bonds or loans. Of course, I'm talking my own book to a certain degree.

Greg Campion: We're both, right?

Scott Roth: Yes. Yeah, both asset classes. And look, I tend to eat my own cooking, but I find it just an effective way to capture higher levels of contractual income from a strategic standpoint. And then you can be opportunistic as well and more tactical on top of that during periods of uncertainty or dislocation where the asset class can offer really significant total return opportunities without taking equity- like volatility. But look, I think there's a lot of just empirical evidence that supports a allocation to the space. There's a lot of history, there's a lot of data here, and if you look the high- yield bond market over the last 35 years, it's generated 250 to 300 basis points of annualized excess return. So that right there would suggest that investors have been overly compensated almost for taking that incremental credit risk and having exposure to the space. Another metric I like to reference is just the risk- adjusted returns. And here broadly syndicated loan market as well as the high- yield bond market have significantly outperformed some of the more traditional asset classes such as investment- grade corporate debt, and emerging market corporate debt as well. I'd say both of these are really supportive of a strategic allocation to the space. Yeah.

Greg Campion: Makes a ton of sense. Take a long- term approach, and I think historically that's been a smart way to play it. Past performance is not indicative of future returns, of course, as our compliance colleagues will remind us. But I think just practically speaking, I think it makes a lot of sense to think about it through a long- term lens. And I think you've done a great job thinking about it through a long- term lens. And we've talked about your career at Barings and considering all of this stuff over multiple decades and having that experience is super valuable. thank you for sharing some of that experience with us today and sharing some of these thoughts with us today. I think it's been very valuable. I've definitely learned something more listeners have too. Scott, thank you.

Scott Roth: Of course. Thanks for having me.

Greg Campion: Thanks for listening to or watching this episode of Streaming Income. If you'd like to stay up to date on our latest thoughts on asset classes ranging from high- yield and private credit to real estate debt and equity, make sure to follow us and leave a review on your favorite podcast platform. We're on Apple Podcasts, Spotify, YouTube, and more. And remember to follow Barings on LinkedIn for all of our latest updates. Thanks again for listening and see you next time.