Franklin High Income Fund Q2 2024 Commentary

Performance evaluation

During the quarter, financial market sentiment oscillated between caution in the face of hawkish rhetoric from central banks and relief at the resumption of the disinflationary trend in the United States. The US Federal Reserve kept its policy rate unchanged during the period, despite two weaker inflation figures, and revised its median rate projection to show only one rate cut in 2024. During the period, the US Treasury yield curve ('UST'), while remaining inverted, steepened somewhat as yields declined for shorter maturities and rose for intermediate and longer maturities. Against this backdrop, the high-yield sector ('HY') posted generally positive returns, despite widening spreads.

Quarterly Key Performance Factors

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Our bias toward ratings quality was a major contributor to relative performance, while our positioning along the yield curve had a largely neutral effect on results. Our industry allocation benefited performance, led by our underweight in the cable and media industries and overweight in the energy segment. Conversely, our underweight in the technology industry detracted from results. Stock selection contributed to relative performance, led by our selection in the non-cable media, financials, and energy segments. Conversely, our selection in the healthcare, cable, and retail industries detracted from results.

Perspectives and strategy

High yield bond fundamentals and technical conditions have remained broadly supportive amid strong capital market access, limited net issuance, and solid investor demand. Balance sheets and financial metrics, including leverage and interest coverage, have generally remained at healthy levels. With average prices still maintaining a healthy discount to face value and nominal yield remaining elevated amid a complementary technical environment, we believe high yield bonds should continue to deliver attractive risk-adjusted returns, absent any exogenous shocks to financial markets. While there are fundamental concerns around some industries that are experiencing challenges, such as pay-TV, broadcasting, media, and healthcare, we believe these concerns are largely already priced in at current levels and overall spread levels should more than offset expected default losses. Amid the strong technical environment, we also note that some erosion of covenant structure and protection has emerged. In this context, we maintain our focus on quality companies, defined by the sustainability of their business models, industry positioning and financial liquidity. We believe that individual stock selection remains critical to portfolio performance.