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High yield bonds - April 2013If there is a bond bubble – what has driven it?
Bond bubble fears are now a common theme, but more recently the high yield sector has come under the spotlight following high returns in 2012, which has resulted in the IMA Sterling High Yield sector recording its first net retail outflows for more than a year.
The latest figures from the IMA show in February 2013 the IMA Sterling High Yield sector recorded £23.7m of retail outflows, the first time since December 2011 when it recorded retail outflows of £14.4m. In the intervening 14 months the sector has seen its assets under management grow from £7.4bn in December 2011 to £9.1bn as of February 28 2013. But is there a bubble and if so, what has driven it?
Ben Pakenham, European high yield portfolio manager at Aberdeen Asset Management, notes: “As is the case for much of the fixed income universe, both sovereign and corporate names, it is certainly true that investors’ thirst for income has pushed up the prices of so-called junk bonds. Benchmark returns last year ranged between 25-30 per cent so a pause for breath, at the very least, would be welcome.”
David Ennett, investment director of high yield at Standard Life Investments, says: “Lots of people say the yield at the moment of 5.1 per cent [on European high yield] is lower than in 2007 but government rates were in a different place at that time. What is more important for us is how much additional compensation you get for holding this higher risk. At the moment the spread over the relevant government bond is 460 basis points (bps), which is more than twice the 226bps you got in 2007, so in terms of additional pick-up you’re getting very well paid.”
Azhar Hussain, head of global high yield at Royal London Asset Management, points out a bubble would mean investors are not getting compensated for the risk they take.
“If we take the US high yield market as an example – as the broadest, deepest (and tightest) market – the current spread levels of 481bps at the end of March adjusted for a projected 3 per cent default rate [from Moody’s] for the next 12 months gives us an excess spread of 308bps which is in excess of the median of 270bps, using data since 1986.”
On this valuation metric high yield therefore seems to be still offering value, but as Melanie Mitchell, co-fund manager of the £1.49bn Kames High Yield Bond fund, points out: “There are many ways to look at valuations in high yield.”
She adds: “So the answer to whether there is a bubble depends on how you’re looking at it [valuation] and which parts you’re looking at [quality]. Obviously you need to get adequately compensated for the risk you’re taking when holding any high yield bond, but those risks are not just about default they are also about liquidity or lack thereof.”
Nyree Stewart is deputy features editor at Investment Adviser
