Check Your Coverage

Head of Fixed Income Strategy
Follow Kevin Flanagan
Director, Model Portfolios
Director, Fixed Income
Quantitative Analyst, Fixed Income

One of the more interesting aspects to the U.S. fixed income markets thus far in 2023 has been the notable shift in economic expectations.

Heading into this year, perhaps the most widely anticipated recession dominated the conversation, but now, the focus has turned to just how resilient the U.S. economy has been, and perhaps a downturn can be avoided.

While there is no doubt that higher interest rates have served as headwinds for housing, commercial real estate and manufacturing, to name a few sectors, another important component to the Federal Reserve’s aggressive rate hike cycle has been the outlook on the financing side of the ledger.

Indeed, higher funding costs have emerged as a key component for fixed income investing in U.S. corporate bonds, especially within the high-yield (HY) arena.

Interest Coverage Ratio as a Barometer for Issuer Health

One of the key barometers used in gauging the strength or weakness of corporate debt issuers is the interest coverage ratio (ICR).

In its simplest form, the ICR allows investors to assess the underlying health of the issuer’s balance sheet by determining how easily they can pay interest expenses on their company’s debt. The general rule is the higher the ratio, the better the issuer’s financial position to make their interest payments, while a lower ratio points to potential difficulties servicing the debt, which could lead to default.

While current ICR levels for the U.S. HY market remain above long-term historical averages, they have recently declined as the impact of higher market yields works its way into interest expense.

U.S. High-Yield Market – Interest Coverage Ratio

Winning by Not Losing

For investors concerned with corporate funding costs amid this move into a higher-yield environment, this recent deterioration in fundamentals may be grounds for reconsidering a broad, market capitalization-weighted allocation to the HY market.

The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) can provide investors a more targeted HY exposure.

Through a systematic, multi-step process, the strategy screens the HY universe to reduce or eliminate exposure to fundamentally weaker credits, then tilts to those remaining issuers, which may offer more attractive income.

The result of this process can be seen through the lens of ICR. The WisdomTree U.S. High Yield Corporate Bond Index, which WFHY is designed to track, currently has less exposure to issuers on the lower end of the ICR range.

% Exposure to Issuer ICR

This can also be seen when comparing relative exposure to issuers with lower ICRs over time.

% Exposure to Issuers with ICR below 2

By seeking to protect investors from issuers most vulnerable to rising funding costs, WFHY aims to win by not losing. As we have previously highlighted, this strategy has been rather effective at limiting the cumulative number of defaults relative to the broader market.

With ongoing uncertainty regarding inflation, interest rates and corporate profit margins, emphasizing fundamentally sound companies with strong cash flows can be a prudent way to access HY credit in today’s macro environment.


Important Risks Related to this Article

There are risks associated with investing, including the possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

Related Blogs

U.S. High Yield: What’s Priced In?

Related Funds

WisdomTree U.S. High Yield Corporate Bond Fund


About the Contributors
Head of Fixed Income Strategy
Follow Kevin Flanagan
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income-related content and travels with the sales team, conducting client-facing meetings and providing expertise on WisdomTree’s existing and future bond ETFs. In addition, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was Managing Director and Chief Fixed Income Strategist for Wealth Management. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S in Finance from Fairfield University.
Director, Model Portfolios
Andrew Okrongly joined WisdomTree in 2022 as a Director on the Model Portfolios Team. He is responsible for the design and ongoing management of model portfolios and custom solutions for portfolio managers and advisors. Andrew is also a member of the WisdomTree Asset Allocation and Model Portfolio Investment Committees. Prior to joining WisdomTree, Andrew was a Director on the Outsourced Chief Investment Officer (OCIO) team at Commonfund, where he was responsible for macro-economic analysis and advising institutional clients on strategic and tactical asset allocation. Andrew began his career at BlackRock where he held a variety of fixed income and multi-asset investment roles. Andrew received a BBA degree from the University of Michigan and is a holder of the Chartered Financial Analyst designation.
Director, Fixed Income
Behnood Noei serves as Director of Fixed Income at WisdomTree Asset Management, where he develops the firm’s suite of fixed income and currency exchange-traded funds and enhances existing investment processes. Behnood has 11 years investment experience in portfolio management and quantitative research. Prior to joining WisdomTree in 2022, Behnood was a portfolio manager and developer of some of the fixed income ETFs at J.P.Morgan Asset Management, where he was directly responsible for managing more than 7 Fixed Income ETFs and multiple SMAs with more than $13Billion in assets. He graduated from The Ohio State University with Master of Science degree in Finance and is a CFA charter holder.
Quantitative Analyst, Fixed Income