Fixed Income  

Doubts raised over high-yield bond claims

Fixed-income experts have raised doubts over the state of the high-yield bond market after recent bullish claims that the bonds were attractively valued.

Hermes Fund Managers’ Fraser Lundie said in a research note that newly issued BB bonds had become attractive to value-seeking investors.

The manager added that 56.4 per cent of BB-rated bonds issued in the past 12 months are trading below par, which puts investors in line for price gains.

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He noted that BB bonds had been particularly affected by tapering fears earlier in the year and had dropped 4 points since the US Federal Reserve announced in May it would consider curbing asset purchases.

“The shake-out, which saw valuations decline from an all-time peak in May, impacted recently issued BB-rated bonds the most,” Mr Lundie said.

He added: “Investing below par reduces risk of capital loss, positions investors for future price gains and provides put options to benefit from buyouts, as more companies – particularly those in the US – consider merger and acquisition activity as they gain confidence.”

But Christine Johnson, head of fixed income at Old Mutual Global Investors, said the asset class looked overbought.

“A year ago, everybody was gripped with fear. The consensus everywhere was that interest rates would be lower for longer and growth would be quite weak,” the manager said.

She added that since most people thought this environment would continue far into the future, BB bonds were released with longer maturity dates, for example a 10-year expiration instead of a five-year.

But Ms Johnson argued there is a different picture for the asset class today, with interest rate risk more of an issue, as the global economic outlook looks more positive.

Because BB bonds were at the top end of the high yield spectrum, the manager added, they were bought by investment-grade buyers desperate for yield now that higher-quality securities were offering less income, and this had pushed up prices.

“We see these parts of the market as very overcrowded; non-[high-yield] bond buyers have squeezed prices and there’s really no value there,” she said.

Chris Higham, manager of the Aviva Strategic Bond fund, said US high yield had not yet fallen far enough in price relative to the risks that remained.

The manager said year-to-date European high yield had done better than US high yield, but overall there were still enough headwinds to stop the high yield asset class from offering compelling value.

“Europe has outperformed, but we would need to see a more significant underperformance from the US before we would make wholesale changes to portfolios, because concerns around tapering and interest rate risk have not gone away,” he said.

However, Aberdeen portfolio manager Rich Smith supported Mr Lundie’s view.

He has upped the credit risk in his Strategic Bond fund, since the companies issuing such bonds were still in good health.

“We’ve increased our high-yield holdings in the Strategic Bond fund from 22 per cent at the end of April to 30 per cent today,” he said.