M&G Investments’ James Tomlins has warned the current volatility in the high-yield market is “not going to go away”, as the firm prepares to launch a new floating rate fund for him.
A warning about the expensive valuations and low liquidity in the high-yield market from US Federal Reserve chairman Janet Yellen earlier this year led to a substantial fall in that sector.
Both the US and European markets suffered significant outflows through July and the start of August.
High-yield funds have since rebounded but Mr Tomlins has warned that investors will be in for a volatile ride in the near term.
“The liquidity issue is not going to go away,” he said.
“Ms Yellen gave a reality check and blew some froth off the market. New issue structures have not been that good in high yield for the past couple of years.
“It is not the end of the liquidity issue; if there is a march to the exit, the doorway is getting smaller and smaller.”
It is into this volatile market that M&G is set to launch a new fund on September 11, the M&G Global Floating Rate High Yield fund.
The fund will invest in floating rate high-yield bonds on a global basis, concentrating on the US and European markets.
The fund is to be launched in response to the changing interest rate environment in the US and UK, with both countries widely expected to raise base interest rates, which is subsequently expected to negatively impact conventional bonds.
Mr Tomlins said floating rate high-yield bonds were a “natural hedge to rising interest rates as capital is preserved”. He also pointed out that floating rate bonds “benefit from rising rates as the coupon goes up as rates rise”.
The manager said the nature of the fund would make it naturally more defensive and less volatile than a conventional fixed rate high-yield fund.
In fact, Mr Tomlins, who is also deputy manager on the M&G Global High Yield fund, said: “At this precise moment in time, it’s a good idea to switch out of fixed rate assets and into floating rate assets.”
He said he would be investing in his new fund, but that he also has a stake in the Global High Yield fund and is happy to hold the two at the same time.
The floating rate high-yield bond market is very young and didn’t really exist until recently.
While Mr Tomlins acknowledged there might be disadvantages to that when it comes to liquidity, he plans to keep a sizeable portion of the fund’s assets in highly liquid credit default swaps.
But he said the fact that the market was not well known provided advantages as well.
He added that the sell-off had been sparked by outflows, particularly from exchange-traded funds and mutual funds, but given that the floating rate market was very new, there were very few funds operating in the space.
Therefore, the floating rate market was not impacted by the sell-off in the fixed rate high-yield market.
Fund selectors react to M&G’s new floating rate fund
Gavin Haynes
Managing director, Whitechurch Securities
Mr Haynes said the fund would “definitely be of interest at this stage of the market cycle as it is a natural hedge against rising interest rates”. He said the fund was “definitely something we are interested in” and that he was in the process of doing more research into it. “M&G has a strong track record of launching products well designed for the current market environment. I hold it in the highest regard due to the strength in depth in its fixed-income team.”
Andrew Alexander
Head of investments, Three Counties
Mr Alexander said he had been doing some work on floating rate funds recently and said it was “fantastic” that M&G had entered the market due to the scarcity of options available. He pointed out the only competitors were loan funds from Neuberger Berman and Alcentra, but that both were investment trusts. “It is good they have come to the table now in anticipation; it is good to see companies being on the front foot. I will definitely be looking at it.”
Scott Spencer
Multi-manager, F&C Investments
Mr Spencer said he had some exposure to the floating rate part of the market but this was largely through strategic bond managers. “We have moved more towards strategic managers and are letting them make the timely asset allocation calls.” He said he would not rule the M&G fund out but that it was not something he was likely to consider now. He said the team preferred to focus on boutique managers, citing TwentyFour Asset Management in the fixed-income space.
