One of the UK’s most respected high-yield bond managers has said claims that the asset class is in a dangerous valuation bubble are “absolute nonsense”.
Phil Milburn, manager of the £1.7bn Kames Capital High Yield Bond fund, pointed to “seemingly endless” attempts to discredit high yield, citing for example national newspapers, which have been referring to the vehicle by the ‘junk bond’ moniker.
In fact, US high-yield markets – on which many of the recent bubble claims have focused – are currently fairly priced relative to previous valuations, he said.
The fierce rebuttal comes amid a torrent of warnings about high-yield prices, with SCM Private founder Alan Miller recently announcing he had sold out of the asset class.
“There has been a huge stampede into this new asset class, where current prices do not fairly reflect the underlying credit risk and liquidity risk attached,” he told the Financial Times in June.
High-yield fears were also stoked by US Federal Reserve chairwoman Janet Yellen, who has warned of a “reach-for-yield behaviour” in the asset class, as investors flocked to income-delivering areas. Her remarks triggered sharp falls on the market.
Mr Milburn said current income from US high yield was “not fantastic” at 5.75 per cent, and he admitted the bonds have “limited capital upside”, but he said the sector still remained more attractive than other areas of the fixed income market.
He pointed out that the spread between the yields of US high-yield bonds and US government bonds has been tighter for 40 per cent of the time in the past 34 years, meaning effectively prices have been higher in those times.
“So provided default rates do not meaningfully increase and one’s timeframe is long enough to look through a few months of mark-to-market volatility, then investors should still earn mid-single-digit returns from high yield,” he said.
“If a bubble means bonds yielding 5 per cent rather than 7 per cent per annum, then the definition must have moved on since I was an equity manager in the late 90s.
“I am not arguing that high yield offers compelling value; I am just trying to inject some realism into the debate.”
According to Lipper data released last week, investors withdrew $7.1bn (£4.2bn) from US high-yield positions in one week, to the end of Wednesday, the largest weekly withdrawal since Lipper records began in 1992.
The outflows have coincided with negative returns from high yield through July and the start of August, which TwentyFour Asset Management’s Mark Holman said were “erasing all the mark-to-market gains of the year to date”.
Mr Holman said the sharp move lower had come about because of “technical” reasons.
He said in June and July there was a “huge supply of debt, particularly in high yield” but not enough cash to absorb it, which pushed high-yield spreads wider.
… or does disaster loom because of a ‘build up of risks’?
Disaster could be creeping up on investors once again as risk-taking pushes asset prices to heady levels, according to the Indian central bank chief who was one of the few economists in the world to predict the 2008 credit crunch.
As chief economist of the International Monetary Fund from 2003 to 2006, Raghuram Rajan warned that risk-taking and financial innovation could end in calamity, earning him criticism at the time from the economic establishment.
But the economist was spectacularly proved right when the subprime financial crisis and credit crunch broke.
In an eerie repeat of his past warnings, last week Mr Rajan, who is now governor of the Reserve Bank of India, told the Central Banker Journal “we are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost”.
“Some of our macroeconomists are not recognising the overall build up of risks,” he said.
“The problems arising are not so much from credit growth… but from asset prices due to financial risk-taking and so on...”
Henderson Global Investors economist Simon Ward, who analyses money supply metrics to predict future economic direction, said there were no short-term signs of a crash in the global economy.
However, he said he did “sympathise” with Mr Rajan’s views in the medium term, as global governments scrap their accommodative monetary policies.
“As these monetary policies turn in the opposite [direction] we really are in uncharted territory,” he said.
Strategists take on the sell-off
The recent sell-off in high yield is only the third largest sell-off since May 2013, according to a Morgan Stanley note last week.
Strategists at Morgan Stanley Wealth Management compared the current sell-off to other recent setbacks and found it wasn’t even the biggest move in the past year.
The analysis concluded that the sell-off was “more likely repositioning and profit-taking than anything more serious”.
“In fact, we believe investors will start looking to put money back to work in higher yield in the coming weeks,” said strategists Jonathan Mackay and John Dillon.
