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By Sumit Desai, CFA | 12-19-2014 10:00 AM

O'Reilly: High-Yield Bonds Should Weather the Oil Shock

Even as oil prices decline, default rates should remain low for most of the high-yield market, says Tom O'Reilly of Silver-rated Neuberger Berman High Income Bond Fund.

Sumit Desai: Hi, I'm Sumit Desai, fixed-income analyst in Morningstar's manager research group. Joining me today is Tom O'Reilly, co-portfolio manager of the Neuberger Berman High Income Fund (NHIAX). His team also manages the Short Duration High Income Fund (NHSAX) and the closed-end Neuberger Berman High Yield Strategies (NHS).

Tom, thank you for joining me today.

Tom O'Reilly: Thank you.

Desai: Tom, it's been an interesting couple of months within the high-yield market. The energy sector makes up a little bit under 15% of the benchmark that you follow, so oil prices can have a major impact on your sector. Can you talk a little bit about what you've been seeing within the high-yield market over the past couple of months?

O'Reilly: Sure. Just to break down the energy sector a little bit more: Although it's 15% of the high-yield benchmark, 5 percentage points is in pipelines. And so these are higher-quality companies [where] it's more of a distribution than a commodity type of credit. So, we don't see a large impact to that part of the market. Still, if you look at the other 10%, it is a large part of the market; but within that 10%, [that is mostly composed of] higher-quality E&P companies. There are some CCCs that are about 1%, which are the lower-quality names. And there's also around 2% in service companies, which we also do see as higher-risk types of credits. But the majority of the energy space within high yield is higher quality.

Desai: So, clearly with oil prices declining, it's caused some of these bonds to sell off. What impact has the energy sell-off had across the rest of the high-yield market? Have you seen any kind of impact there?

O'Reilly: Sure. If you look at valuations in the market now, high yield versus energy, energy is trading at the widest valuation that it's ever traded relative to high yield. In terms of yields, energy is around a 10% yield and high yield is around a 7% yield. Over the last few weeks, we have seen a spill-over into other high yield, primarily as we've seen outflows in the space; that has created widening across all high yield. That being said, the last few days, we've seen a lot of strength as we think the market has been oversold and started reaching yields almost close to 8% on the overall benchmark, and that drove more money back into the market itself.

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