High yield triumphs as income-hungry investors boost bonds

The prospect of the end of quantitative easing, dangled in June by Federal Reserve chairman Ben Bernanke, ensured that developed market government bonds finally reversed their long-run of strength, but there were also safe havens.

In aggregate, in the past 12 months, corporate bonds have beaten government bonds, and higher risk corporate bonds have beaten lower risk corporate bonds, but this does not suggest that fixed income markets have been all about a ‘risk-on’ trade.

The area to avoid above all has been emerging market debt, where its recent run of popularity sharply reversed. Equally, investors needed low sensitivity to interest rates in their portfolios, meaning they were better off in shorter-dated or floating rate bonds with greater credit exposure over those trading closer to government bonds.

The top IMA sector overall was Sterling High Yield, where funds returned an average of 6.2 per cent. Next was Sterling Strategic Bond, where the average fund rose 3.1 per cent. The top fund in the sector was the GAM Star Credit Opportunities fund, managed by Anthony Smouha of Atlanticomnium, whose portfolio was split between positions in the lower rated debt of stable companies and a significant weighting in floating rate notes. The latter had a strong year on the prospect of higher interest rates.

Floating rate notes helped the performance of the TwentyFour Focus and Dynamic Bond funds, which also held higher weightings in the profitable areas of financials, asset-backed securities and high yield.

It tended to be funds prioritising a higher yield, and therefore with higher exposure to high yield bonds, that performed best. The same was true in the Sterling Corporate Bond sector, where those funds holding higher risk bonds, and with more credit rather than interest rate exposure, were top of the performance tables. The Rathbone Ethical Bond fund with its higher yield target and higher weighting in financials had a strong year.

The average gilt fund dipped 2.2 per cent, but the worst performance by far was seen in the Global bond sector, where the average fund fell 4.3 per cent. This was largely on the back of the weakness of funds exposed to emerging market debt – Pictet Latin American Local Currency debt and Western Asset Asian Opportunities funds were particular victims, dropping 18.1 per cent and 13.2 per cent respectively.

But this also affected some flagship funds, such as the Templeton Emerging Market bond fund, which fell 7.9 per cent.

Euan McNeil, fixed income investment manager at Kames Capital, says: “Last year saw a big upward movement in yields, but the strength seen in credit markets was enough to offset that.

“There was a significant compression in credit spreads. The markets did see a wobble in May and June when they got an inkling of Fed tapering, but in Q4 they got comfortable with the withdrawal of monetary stimulus.”

Looking ahead, he believes it may not be such a strong year for credit markets, and opportunities will be more selective: “Our experience is that we will continue to see a gentle upward drift in yields as data continues to show recovery.

“That said, it is difficult to see credit spreads making much progress during the year, as credit is pretty fully valued. There are some opportunities in financials, but stock selection is likely to assume far greater importance.”

The benign environment for fixed income appears to have ended, though there has, as yet, been no great rotation out of bonds. As yields have moved higher, new income-hungry buyers have moved in to support the market.

Equally, economic growth is not yet assured, meaning fixed income markets could still surprise in 2014.

Cherry Reynard is a freelance journalist