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.
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.
Lundie warns on rush for short duration
Fraser Lundie (pictured), co-head of credit at Hermes Fund Managers, has warned that investors could lose out on returns as issuers are increasingly reducing the period during which they are guaranteeing not to refinance their debt.
He referred to a “structural creep” as high demand for bonds with a shorter lifespan – which are less sensitive to movements in interest-rate expectations – had allowed issuers to reduce “call protection”.
“Call protection benefits investors in a rising rate environment and extends the period in which they can be exposed to the price gains of well-performing [bonds] – and therein lies the equity-like returns investors have come to expect,” Mr Lundie said.
“However, recent demand for short-duration debt, combined with an undersupply of new issuance, has allowed companies to bring forward the dates at which they can redeem bonds. Since 2010, non-call periods worldwide have almost halved from 6.8 years to 3.6 years.
“This [is] a sign that issuers are winning the power struggle with investors over terms and pricing.”
