With economies performing well, central banks are looking to gradually tighten monetary policy. This could represent a double whammy for high-yield investors. Bonds tend to perform badly as interest rates rise because their yields look less attractive. At the same time, high-yield bonds specifically are closely correlated to equities, which could suffer as monetary stimulus is withdrawn.
“It will take a while for that [tightening] to happen, but high yield will be vulnerable,” says Mr Kyle.
The proposition may seem less attractive than it once was, but investors need not throw in the towel just yet. Like equities, high yield can look expensive while at the same time continuing to enjoy benign economic conditions. As such, clients may wish to keep participating as asset prices rise.
“On the plus side, the economic expansion continues apace, defaults remain low and so too do recession risks, though bear in mind that high-yield bonds correlate fairly closely with equity investments,” explains Mr McPherson.
“High-yield markets offer decent yields, but [investors] need to be very selective on how to own them.”
Mr Kyle strikes a similar note, explaining that investors should limit the extent to which they are exposed to the lowest quality high-yield debt, because the compensation on offer does not justify this.
“If you go too far down and get to CCC [rated bonds], if they go bust there would be nothing left,” he says. “The spread doesn’t compensate [for the risk taken].
“There are still a lot of opportunities in the retailers and energy companies that have been beaten up. Fundamentals can be good and the market is mispricing them, but there’s not the same opportunity that there was. It’s about making a bet on a manager who has a good track record of avoiding defaults and finding decent issuers. There will be funds with hedge trades and differentiating buckets.”
Some professional investors have opted to turn to strategic bond funds for their high-yield requirements, because of the flexibility on offer.
“We feel the risk of owning high-yield bonds is now becoming more asymmetric,” says Jonathan Moyes, head of research at discretionary firm Whitechurch Securities.
“Instead, we are finding value in specialist strategic bond mandates with more defensive positioning.”
Buying locally
Those still opting for a dedicated high-yield fund would do well to consider exposure to specific sectors and levels of credit quality. The latter can make a significant difference: according to Moody’s, the average yearly default rate in CCC-rated bonds from 1990 to 2017 was 13.1 per cent. Higher up the quality spectrum, this rate was just 3.7 per cent for B-rated debt. But the market an investor chooses to focus on also has a material impact.
