Fund Review: Investors moving up fixed income risk spectrum to high-yield bonds
The search for yield has led to many investors moving up the risk spectrum when it comes to fixed income, but high-yield bond funds were sporadically popular at best last year.
Investment Association figures show July and August 2016 saw net retail inflows into the IA Sterling High Yield sector of £79m and £39m, respectively. However, this popularity did not last, with the sector recording outflows of £158m in September and £131m in October.
Globally, US high yield did well last year, with the BofA Merrill Lynch US High Yield index rising 36.1 per cent in sterling terms for the year to date to December 13, while the BofA Merrill Lynch Global High Yield index climbed 33.2 per cent in sterling terms during the period.
Tom Becket, chief investment officer, Psigma Investment Management, says: “A common view at the start of 2016 was to avoid US high-yield credit. We disagreed and thought the ‘blow-out’ in spreads suffered by high-yield bonds in 2015 offered patient investors both capital recovery and an income opportunity.
“We felt the excess yields that could be found on lower-rated bonds were only realistic if we were to see a tsunami of corporate defaults. Fortunately, our view was correct. We still feel that in both the US and European markets you are being compensated for taking credit and liquidity risk in smaller and lower-rated bonds, as spreads on such bonds are wide compared to higher-rated and liquid corporate debt issues.”
But Rosie Bullard, portfolio manager at James Hambro & Partners, says investors need to understand that high-yield bond markets “can deliver volatility”.
She explains: “The Markit iBoxx Global Developed Markets High Yield index was down 14 per cent from mid-2014 to early 2016 but bounced 15 per cent from then to December 5 2016, in US dollar terms.
“This was unusual and partly due to the collapse of oil prices. A selective, active manager might have avoided some of the pitfalls, but for those of us who believe the bond element of portfolios should deliver capital stability and income, it is an unwelcome risk. If interest rates revert to mean, there will be serious pressure on bond markets.”
The US election at the end of 2016 created further uncertainty. Peter Aspbury, European high-yield portfolio manager at JPMorgan Asset Management, says: “The rise in government bond yields after the US election has had a negative result on the high-yield market. High-yield spreads in Europe and the US have also widened as investors reappraise their exposure. This sharp sell-off in rates has been accompanied by a rise in equity markets. While it’s too early to call the end of the central bank dependency cycle, [there] has been a welcome return to normality whereby a sell-off in interest rates coincides with improved investor risk appetite. Should this last, we think high yield is set to outperform the rest of the fixed income market.”
He points out that in Europe, where the high-yield market has less than 3.5 years of duration, the corresponding investment grade market has almost two more years of duration – meaning almost 60 per cent more sensitivity to a move in yields.
“Furthermore, there is the spread advantage. The higher yield that results from higher spreads means high-yield investors should get more of a cushion for the adverse impact of rate moves.”
