Fixed Income  

‘Crowded trade’ in BB bonds pushes managers to up risk

Bond managers are moving to riskier areas of the high yield market in an effort to counteract the asset class’s increased sensitivity to interest rates.

Investment Adviser reported last month that investors searching for sources of income had pumped more money into high-yield bonds, pushing prices up and making the securities trade more closely in line with investment-grade and government bonds.

Retail investors in the UK put a net total of more than £300m to work in the IMA Sterling High Yield sector in 2013, according to IMA data.

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James Tomlins (pictured), co-manager of M&G Investments’ High Yield Corporate Bond and European High Yield Bond funds, said there was a potential “crowded trade” in BB-rated bonds, one step down from investment grade.

The manager added: “2013 was a bad vintage for high yield. 2011 and 2012 were very good years for issuance because only the best companies could raise money, [but in 2013] we saw companies that would not have got refinanced in the past.

“A lot of issuance was to finance dividend payments. We only participated in 1 in 5 deals last year.”

Instead, Mr Tomlins highlighted opportunities in “special situations” and “distressed debt” as providing more potential for capital appreciation.

“This environment makes distressed debt look more interesting,” he said. “Everything is distorted by quantitative easing. To get the minimum distortion you need to go far away from government debt – for example, special situations and distressed debt.”

He and co-manager Stefan Isaacs have a top-10 position in bonds issued by the Bank of Ireland in their £143.3m European High Yield Bond fund.

Mr Tomlins said: “This is all about the Irish recovery story. I don’t think it has a genuine risk of default. Ireland has just completed its exit from the International Monetary Fund programme, and the bank’s balance-sheet repair is well on its way.”

The manager also cited a smaller holding in Hungarian telecoms provider HTC, which last year defaulted on its debt, forcing bondholders to take a 50 per cent writedown to their investments. The M&G managers subsequently bought in at a price equivalent to 45 cents for every euro, which is scheduled to be paid back at the bond’s maturity.

“That kind of opportunity is far more interesting,” Mr Tomlins said.

“We got a 7 per cent cash coupon with a 2 per cent ‘payment in kind’ as well as equity. There is a very clear mandate for the board from the bondholders to turn the business around.

“The consensus is CCC is bad value but I think there is some great value in this area if you go to distressed debt.”

Nick Gartside, manager of the JPMorgan Strategic Bond fund, maintained that high-yield bonds “still look attractive” in certain areas, even though he admitted the asset class has “more interest-rate sensitivity” at current levels.

He said he was selling Treasury futures to “strip away the interest-rate sensitivity” of high-yield holdings.