Fixed IncomeMay 18 2015

Fund Review: Hermes Global High Yield Bond

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The aim of this £189.2m Hermes Global High Yield Bond fund is ultimately to beat the returns of the global high-yield market, manager Fraser Lundie says.

The fund reached its fifth anniversary on May 11 2015, and its investment process has remained consistent. Most of the credit team at Hermes – particularly the duo of Mr Lundie and Mitch Reznick – has been working together for more than a decade.

Mr Lundie explains: “The process starts with a top-down construct, which is the output from our monthly credit strategy meeting where we go through what we perceive to be the major drivers of credit appetite. [It comprises] all the things you’d probably expect from a top-down point of view in terms of balance sheet health, earnings, funding and liquidity, and so on.”

The result of the meeting – which also looks at the relative value of credit – is “a conclusion on where we want to allocate capital within the wider universe”, he says. This includes geography, the sector, ratings categories and which parts of the interest rate and spread duration curves to target. “That gives us two things: First, an overall construct of how we’d like the portfolio to look, and second it acts as a filtering device for us to then go away at an analyst level to look for bottom-up ideas to fill out the shape of the portfolio we’d ideally like to have,” Mr Lundie says.

This analysis is then put to the credit committee, which scores the credit on fundamentals and relative value to produce a final score of between one and five. He explains: “It could be the best credit in the world, in which case it would be one out of five on fundamentals, but if it’s priced to perfection then it would be five out of five on relative value – so the final score could be a three. The way we look at the world is that everything should be a three if it is priced correctly to its risk, so we are looking to populate the fund with ones and twos in the areas of the market that we like.”

These ideas are then presented to the risk management meeting, which “slices and dices” the risk in the portfolio. He notes: “This meeting completes the circle and makes it dynamic and continuous. It is the threefold process of credit strategy, credit committee and bottom-up ideas and then risk management, which we’ve done for 11 years or more.” However, the manager points out the process has not remained completely static as “there is always going to be an element of evolution in terms of the way the market and technology evolves”.

The fund sits at level four out of seven on a risk-reward scale for the F-sterling hedged accumulation share class, while ongoing charges are 0.79 per cent, its key investor information document shows.

Since launch on May 11 2010 to May 8 2015, the fund’s Z-sterling accumulation share class returned 36.03 per cent compared with the IA Sterling High Yield sector average of 35.24 per cent. Meanwhile, the F-sterling hedged share class – the post-RDR primary share class launched in February 2014 – has returned 9.09 per cent since launch to May 8 2015 compared with the sector average of 4.08 per cent .

The manager notes the major change in the last four to five months has been the increased exposure to the US energy sector, as the team has been “consistently buying high-quality US energy companies throughout this period of significant weakness, which really began at the start of the fourth quarter of last year”. He says: “Valuations have moved pretty dramatically and we now see significant relative value versus other sectors. [There has been a] shift in the portfolio to go from nothing to the mid-to-high teens in terms of percentage exposure to the space.”

Mr Lundie attributes the steady performance to a successful top-down allocation of capital, such as preferring emerging markets and US high yield to Europe in recent months.

He acknowledges, though, that a major detractor from performance “would be our overly conservative view on interest rate duration”. He adds: “We have been in an environment where interest rates are at record lows and that’s been a headwind for the overall performance of the fund, but I wouldn’t necessarily do anything different. I see part of this mandate as being capital preservation as much as returns.”

EXPERT VIEW

Martin Bamford, chartered financial planner and managing director, Informed Choice

Manager Fraser Lundie has run this fund for five years, which is long enough to make judgements about his track record. The underlying portfolio is reasonably diverse and has a shorter duration than the benchmark, which will hopefully bode well once yields start to rise. More than half of the fund assets are located in North America, which means investors have a high exposure to this region in spite of reasonable levels of diversification from other aspects of the fund.