Fears of a market correction and problems with selling positions have prompted Investec Asset Management’s John Stopford to slash his exposure to high yield.
The manager said he had already cut high yield exposure in his multi-asset £90m Diversified Income fund to 25 per cent from 33 per cent in recent months, but added he was likely to take his weighting into the teens.
“I am worried the asset class is becoming somewhat unstable and vulnerable to a correction,” he said.
The manager added he was also worried about the lack of liquidity in the market, which can hamper the ability to sell positions when everyone is running out the door.
“There is no problem with liquidity when you are buying in because of the number of new issues, as companies realise they can issue debt at such low yields.”
Mr Stopford said the problem with liquidity will come when the market first starts to sell off and investors all rush for the exit at once. The lack of market makers could see investors stuck in assets that are tumbling in value, unable to find a buyer.
“It is a very crowded trade and there is an increasingly low number of market makers,” Mr Stopford said.
The manager said high yield “should be playing a smaller role” in an income portfolio at present, due to these risks.
The most recent Bank of America Merrill Lynch global survey last week found US high yield was seen as the second most crowded trade in all markets by fund managers, only just behind peripheral European debt.
Mr Stopford is using some of the money gained from selling high yield bonds to increase his already large weighting to emerging market debt, which had already gone through a period of weakness in the past year and now seems to be gaining popularity.
He said the market had “gone out of fashion” in the past 12 months, but the sell-off had meant the “yield spread between emerging market and developed market debt is now looking attractive”.
The manager said he was adding to the region “selectively”, due to the different prospects for various emerging market economies.
He highlighted Brazil as one area he favoured adding that in spite of the “problems” in the economy, investors were being paid for the risk with a “real yield” after inflation of more than 6 per cent.
He said the emerging market portion of the fund had a combination of bonds denominated in their local currency and bonds denominated in dollars, called ‘hard currency’, so the fund is taking some currency risk within emerging markets.
At the end of March this year, the Investec Diversified Income fund had 26.8 per cent of its portfolio invested in emerging market debt, making it the second-largest asset weighting, only just behind equities.
But Mr Stopford said he was likely to continue adding to the asset class using the money from selling high yield, though he would also use that money to add to higher grade developed market corporate bonds as well.
He said he was looking to broadly go up the quality spectrum, investing in bonds with a higher credit rating, and reducing the fund’s duration, which is its exposure to movements in interest rates, at the same time.
The Investec Diversified Income fund is in the third quartile of the IMA Mixed Investment 20-60% Shares sector for performance in three and five years, though it is bottom quartile in the past year.
However, the fund is at a disadvantage compared to its peers in that it cannot have more than 40 per cent exposure to equities.
This means that in bull markets, such as we have seen in the past five years, the fund cannot keep up with peers that will generally have closer to 60 per cent within equities.
