A plunge in the value of high-yield bonds in the second half of 2014 has pushed Regina Borromeo’s Legg Mason Income Optimiser fund to the bottom of the performance charts.
The fund has fallen into the bottom quartile of the IA Sterling Strategic Bond sector in the past year, which has also caused the fund to slip below its peer group average for three-year performance.
The underperformance has come from the fund’s high weighting towards high-yield bonds, in spite of the manager selling a large proportion of its high-yield bonds early in 2014.
But the fund still had more than 50 per cent of its money in the asset class in the second half of 2014, with performance consequently suffering.
Ms Borromeo said high-yield bonds were hit by a pick up in general volatility, exacerbated by specific issues with bonds from Phones4u and then Tesco.
She said risk aversion driven by the dramatic collapse in the price of oil then caused a further sell-off in high-yield assets that, in the US especially, had high exposure to the oil and gas sector.
The relative underperformance on the fund was exacerbated by the fact that government bonds rose in value as high-yield bonds sold off, leading to a widening in the difference between the yields on the two assets, known as the spread.
So while investors in high-yield bonds lost money, those who held government bonds from the US or UK gained.
Ms Borromeo said: “In hindsight, because there was a spread widening in global high yield, owning any high yield would have hurt anyone.”
The fund has generated a return of 1.6 per cent in the past year, below the sector average return of 5.9 per cent, while in the past six months it has lost investors 2.6 per cent, according to data from FE Analytics.
Ms Borromeo said the “hiccup” was partly a result of the fund’s mandate to provide a high income for clients which, in a world where government and highly rated corporate bonds are nearing record low levels of yield, has necessitated a high weighting to such assets as high yield.
She said: “For investors looking for a higher income distribution, the main segments would be higher yielding corporates and higher yielding sovereigns such as in emerging markets.
“Emerging markets and high yield were the focal points for the sell-off in the final four months of last year.
“Even though we had some hedges in place and took some profits, having a net long exposure to these segments was a short-term headwind for the fund.”
The fund’s exposure to high yield was reduced throughout last year, from 74 per cent to roughly 50 per cent by year-end, while Ms Borromeo has also been reducing the fund’s holdings in emerging markets corporate debt.
However, Ms Borromeo said she now thought there were pockets of value in high yield and has begun to selectively invest in some oil-focused high-yield stocks that she feels have been sold off too heavily.
Lundie targets US high-yield bonds following sector sell-off
Hermes fixed income manager Fraser Lundie has been ramping up his exposure to US high-yield bonds following the sell-off in the sector.
Mr Lundie said for the first time in about two or three years the valuations on US high-yield bonds were beginning to look “reasonably good”.
High-yield bonds have suffered relative to government and corporate bonds in the past six months, which has seen the value of the bonds fall and the yields rise.
A big reason for the decline has been the impact of the drop in the oil price, which has dragged down the US high-yield market, which has significant exposure to oil companies.
But Mr Lundie said higher quality oil bonds, from firms that should not default even with a low oil price, have been dragged down as well as lower quality names that are at risk of default.
So the manager said he had recently been buying higher quality oil-focused high-yield stocks.
He said US high yield bonds should outperform their European counterparts because many companies that issue high-yield bonds are reliant on economic growth for their business models to work, but while there is substantial growth in the US, the eurozone is expected to struggle for growth.
