Hot and not: Where to pick up high yield bonds

We surveyed a series of high yield bond fund managers to find out where they think is hot, and where should be avoided.

Azhar Hussain, head of global high yield, Royal London asset management:

Likes: US, Poland

Dislikes: high growth parts of the world/emerging markets, parts of Europe

“If we split the world into the US, Europe and rest of the world (ROW), then the US is the best environment for high-yield corporates and valuations continue to remain compelling. Europe is patchier due to the weaker macroeconomic climate meaning that you have to pick your pockets of value. We like Polish corporates for example but would steer clear of Hungary or Portugal. The ROW is similar; this is a disjointed series of jurisdictions which are sector heavy, essentially dominated by homebuilders in Mexico, Livestock companies in Brazil, Property companies in China and Mining companies across Asia and Africa.”

Melanie Mitchell, co-fund manager of the £1.49bn Kames High Yield Bond fund:

Likes: US

Areas to avoid: peripheral Europe

“The area we are choosing to avoid at the moment, or certainly be underweight on, remains peripheral Europe. The risk that is higher there than in non-peripheral Europe is volatility risk because people are cognisant of the higher fundamental risk in those areas. Therefore bonds that are issued out of the periphery tend to be more volatile than bonds issued from northern or central Europe jurisdictions so you need to get paid more in terms of your yield to be a holder of those bonds. In Europe, we’d rather be in the core economies but for a long time we’ve preferred the US high-yield market over the European high-yield market. That reflects two things, the first is that the US economy is far less challenged than the European economy is at present. But also the valuations you get paid to take on US high-yield risk are more favourable at present at a generic level.

“Should there be a sharp sell-off in European high yield and the US market held firm such that Europe became radically cheaper, we would be happy to reverse that portfolio positioning to a degree.”

Christine Johnson, manager of the £33.4m Old Mutual Monthly Income Bond fund:

Like: Europe

“High-yield investing at the moment is a bit of an odd topsy-turvy world. In a sensible fundamental way, these companies tend to be the most GDP sensitive end of the fixed income universe so you would intuitively want to invested in the areas where growth is better established – perhaps the US or even those with emerging market exposure.

“However the drivers for the asset class are almost the reverse – it’s the yield bit people want – and high yield as an asset class, and especially lower-rated high yield, actually produces the best returns in a ‘disinflationary’, but not deflationary, environment. That is where growth is flat but inflation is actually falling – and it’s that environment you find in Europe. Very low government bond yields make the yields attractive – falling inflation makes every coupon paid worth that little bit more on a real return basis. Of course with very low all-in yields that is where the hard work can’t be neglected – you’ve got to get paid that coupon. Yields are relative, but defaults are absolute.”

Chris Higham, manager of the £73.1m Aviva Investors High Yield Bond fund:

Like: Core Europe, UK

“We continue to see value in European high yield based on our expectations for continued low interest rates and low levels of economic growth. While banks, household and government balance sheets remain in poor shape, the corporate sector remains strong. We continue to see low default rates amongst corporate as they act prudently in the face of uncertain economic conditions.

“Particular opportunities include the corporate hybrid part of the market where investors are able to achieve more attractive yields for subordinated debt within corporate with investment grade credit profiles. An example within high yield might include KPN, the Dutch telecom operator. Geographically we continue to prefer core over peripheral economies, and as high-yield companies are more economically sensitive, we prefer companies operating within a positive economic growth environment.”

Russ Covode, co-lead manager on the $8.9bn (£5.8bn) Neuberger Berman High Yield Bond fund:

Like: US

“We expect the US economy to grow at roughly 2 per cent in 2013. Against this backdrop of stable, modest growth, US corporate fundamentals are very strong. Downsizing during the recession has generally produced lean organisations, with less vulnerability to economic weak-ness. Capitalising on the low interest rates of recent years, many companies have taken the opportunity to refinance and strengthen their balance sheets. Earnings for the S&P 500 index are forecast to grow 10 per cent this year.”