Strategists and multi-asset managers are betting on a recovery in the high-yield market, in spite of several months of dismal returns for US credit in particular.
The US high-yield sector experienced its worst performance in four years in September, according to TwentyFour Asset Management.
But some managers remain positive over the opportunities in the sector.
Psigma Investment Management chief investment officer Tom Becket said the small-cap US high-yield sector in particular looked extremely attractive.
Mr Becket said he was disappointed with the recent downturn in that sector, with its third-quarter performance undoing a “great start” to 2015.
But he still thought it was the best risk-reward opportunity in the market, as valuations were “outrageously” cheap and his own fund’s holdings yielding 12%.
“As we look forward, the outlook should be very supportive of the credit returns – moderate growth, moderate inflation, moderate interest rate rises and moderate corporate profitability are a healthy combination for high-yield credit,” Mr Becket said.
He added that he expected defaults to stay low in the upcoming environment.
Another market participant eyeing high yield is Standard Life Investments’ Bambos Hambi, who runs the MyFolio range.
The manager is currently neutral on high yield, a position he has held for one year after being overweight in the previous four years.
However, he is considering returning to an overweight allocation, tempted by the 7 to 8 per cent yields on offer in the US.
“[These yields are] equal to a default rate of about 25 per cent and we don’t think you will get anywhere near that… the default rate is likely to be in single digits,” Mr Hambi said.
JPMorgan Asset Management (JPMAM) chief market strategist Stephanie Flanders made a similar recommendation.
She noted returns were difficult to generate in the current environment, but recommended investors looked to high yield as she expected defaults to be low in the coming months.
Ms Flanders thought high-yield bonds were “oversold” during the market uncertainty and were now pricing in a lot of the negativity.
This was particularly true of US energy high-yield bonds, which were offering better returns than other areas of the market and had already endured the majority of their pain, she added.
According to JPMAM, the annualised average return for high-yield bonds in the past 10 years has been 8 per cent, making it the second-highest generator of returns.
Meanwhile, TwentyFour Asset Management chief executive Mark Holman said he was bullish on European high yield, with indices close to yielding 6 per cent to maturity – not seen since 2013.
Mr Holman said the yield on the European index would need to reach 8 per cent before it made investments unviable, based on an assessment of 12-month break-even rates.
This ability to provide income at a time of diminishing returns has already served holders of European junk bonds well this year.
Prices have dropped, but income from the bonds has more than offset the loss of value.
Bond managers keep cautious approach to asset class
Some bond managers are more cautious on their own asset class.
Bryn Jones – who manages the Rathbone Ethical Bond and Rathbone Strategic Bond funds – is bearish on high yield because of his concerns about the quality of issuance, the level of compensation offered for the risk taken and the possibility of defaults.
“The quality of high yield is a lot worse than it was,” Mr Jones warned. “There are also a number of highly geared energy companies [in that sector].
“The default level is likely to rise at some point this year.”
Similarly, in anticipation of a turning credit cycle, Jupiter Asset Management’s Ariel Bezalel has slashed the exposure in his £2.6bn fund.
Last week the manager told Investment Adviser he had 30 per cent in non-financial high-yield debt, down from 50 per cent earlier this year.
He said the weighting would fall further in the coming weeks.
