25 | 2023 Investment Outlook | December 12, 2022 HIGH YIELD The Lure of Long-Term Value KEY POINTS Corporate fundamentals of high-yield issuers are, on average, closing out 2022 1 from a place of strength, but may face strong headwinds in 2023. Stephen C. Concannon, CFA We favor defensive sectors and higher-quality credits, particularly where long- Co-Head of High term value is present. Yield, Portfolio 2 Manager We stand ready to add risk in a disciplined manner when spreads exceed defined 3 thresholds. What We Are Seeing ƒ In 2023, we expect to see a shift in focus toward slowing global growth. Monetary policy will Will Reardon remain a prominent market driver, but the prospect of recession in several developed markets Institutional Portfolio will likely be a trigger for volatility throughout the year. Manager, High Yield ƒ In high yield, corporate fundamentals still appear to be somewhat resilient, and the market is entering 2023 from a place of relative strength. Leverage appears to be manageable, and interest coverage is hovering near all-time highs. ƒ However, strong fundamentals at the end of 2022 are likely to weaken in 2023. In particular, we expect corporate earnings to fall in line with slowing business activity at the same time that interest coverage softens—especially for issuers with elevated exposure to floating-rate debt. ƒ Primary issuance, which remained languid throughout 2022, may start to increase in 2023 as companies become more comfortable with a regime where interest rates remain higher for longer. What We Are Watching ƒ Receiving adequate compensation for taking credit risk is what drives our investment decisions. Therefore, we are re-underwriting our investments to ensure appropriate payment for the underlying risks, while also seeking out attractive upside in an environment of rising credit risk. ƒ We deem current valuations to be fair, on average, but foresee further spread widening as the most likely path forward. Should spreads move materially wider, we could see an entry point emerge that offers the potential for attractive long-term risk-adjusted returns. To this end, taking a disciplined approach to incrementally adding risk when credit spreads surpass defined thresholds will be key for high yield in 2023.