Introduction
The grouping has seen outflows in eight of the past 12 months since March 2015, peaking at -£143m in December.
It’s no surprise that investors have been leaving the sector, which has underperformed most other IA fixed income categories over one year.
The average return from the Sterling High Yield sector is -0.9 per cent, while the IA Sterling Strategic Bond group delivered an average -0.01 per cent across the 12 months to May 5 2016. But corporate bond funds and UK gilts both generated positive returns in the period, justifying their place in investors’ portfolios. The IA Sterling Corporate Bond sector delivered an average of 1.7 per cent, while IA UK Gilts returned 5 per cent.
So why should investors allocate to high-yield bond funds?
| THE PICKS |
Aviva Investors High Yield Bond Run by Chris Higham, this £149m fund has outperformed the IA Sterling High Yield sector over one, three and five years, data from FE Analytics shows. For the five years to May 5 2016 the vehicle delivered 36.6 per cent, against the sector’s average return of 21.6 per cent. Mr Higham’s objective is to generate a high level of income by investing in global bonds issued by companies and governments, with 80 per cent of the bonds in the portfolio priced in sterling. The fund’s factsheet to the end of April shows it has 56.1 per cent allocated to international bonds and 37.8 per cent to UK corporate bonds. Baillie Gifford High Yield Bond Managed by co-managers Robert Baltzer and Donald Phillips, this £714m fund launched in November 2001 and has generated consistent returns since then. Over the past three years to May 5 it has returned 10.7 per cent, ahead of the IA sector average of 6.6 per cent, according to FE Analytics. The fund seeks a high level of return through a combination of capital growth and income payment, and invests mainly in sub-investment-grade bonds. The portfolio comprises between 50 and 90 holdings, with 11.4 per cent exposed to the capital goods sector, followed by 10.5 per cent in financial services. EDITOR’S PICK Threadneedle High Yield Bond This £741m fund is co-managed by Barrie Whitman and David Backhouse, with the former boasting a more than 22-year career in high yield. The vehicle has built up a solid track record, delivering 71.3 per cent in the 10 years to May 5, compared with the peer group average of 63.9 per cent, data from FE Analytics shows. Among the top 10 issuers in the portfolio are Virgin Media, Gazprom and Fiat. The fund’s largest sector weighting is to the media sector, which makes up 12.2 per cent, while telecoms accounts for 11.9 per cent. |
Dr Axel Potthof, portfolio manager of European high yield at Pimco, says “fallen angels” could boost the global high-yield bond universe this year.
He explains: “Fallen angels are issues whose credit ratings have been cut from investment grade [BBB- or higher] to high yield [BB+ and below]. While this trend may appear troubling to investment-grade managers, for investors targeting high yield it isn’t necessarily a bad thing.
“Fallen angels are often higher quality than the average high-yield company and may have a better chance of returning to investment grade. Hence an influx of these companies could boost the long-term return potential of the overall high-yield sector.”
If there is a higher-than-average volume in fallen angel bonds globally in 2016, he predicts this could swell the high-yield market in Europe by 10-12 per cent and provide investment opportunities “as the downgraded issuers will likely be more diversified across sectors than in the US, where we expect the majority of downgrades to come from the commodities sector”.
But Dr Potthof warns: “While fallen angels have historically outperformed, we shouldn’t assume they always will or that they come without risk. For example, in 2010 and 2011 they underperformed due to subordinated bank debt and peripheral eurozone bonds. Identifying the strongest of the fallen angels was critical during this time.”
James Tomlins, who manages the M&G Global Floating Rate High Yield fund, suggests a recent widening in high-yield spreads makes the sector’s floating rate notes (FRNs) an attractive prospect for income investors, with scope for capital gains should spreads tighten.
He says: “With a higher concentration of senior secured issues, high-yield FRNs offer a lower volatility alternative to conventional high-yield bonds. Finally, FRNs contain virtually zero interest rate risk – for investors who are concerned about the low level of government bond yields [and a possible sell-off in this market], FRNs may offer an appealing proposition.
“There is an opportunity cost involved with a zero-duration strategy – if interest rates remain at current lows for an extended period, then long-dated duration strategies are likely to see the most benefit. That said, given the low level of government bond yields across the developed world, we don’t see the opportunity cost as being that expensive.”
