Best in Class: Baillie Gifford High Yield Bond

It seems the remarkable flight to safety caused by the Covid-19 pandemic has given high yield bond fund managers the opportunity they have been waiting a decade for.

Having already tapped into opportunities in the investment grade space, high yield does look a logical – albeit riskier – next port of call, given the attractive yields it offers dividend hungry investors.

This is a truly unique sell-off which has resulted in well-run businesses struggling for sales, routing their cash reserves and taking on more debt to survive during lockdown.

With defaults on the rise, picking the right active manager is essential.

However, the Federal Reserve has committed itself to buying both investment grade and some high yield issues in an attempt to underpin the market.

Then there is the fallen angels – the likes of Marks and Spencer and Renault - which have been downgraded from investment grade.

I saw a chart from LGIM recently, which predicted $800bn worth of fallen angels should we get a ‘U’ or ‘W’ shaped recovery – that’s a lot of downgrades.

So, the opportunity is there, but with defaults on the rise, picking the right active manager is essential. This week’s Best in Class has proven its case by delivering 60 per cent fewer defaults than the market average over its 18-year track record.

The Baillie Gifford High Yield Bond fund is managed by Robert Baltzer and Lucy Isles. Mr Baltzer joined Baillie Gifford in 2001 and heads the high yield team.

He has run this fund since 2010, with Ms Isles joining as co-manager in 2018.

The strategy is stock-specific and ideas will come from a variety of sources, but all will have the key feature of resilience - whether from the company’s competitive position, financial structure or its management team.

These ideas will then be analysed for potential risks, the profile of the company’s debt and their current valuation. The managers will set milestones for their holdings in order to look for opportunities to buy or sell.

They run a concentrated portfolio of 50 to 90 issuers. Average holding sizes are between 1 per cent to 2 per cent with relatively low turnover.

Speaking in May, Ms Isles said the recent volatility had meant that, for the first time in years, BB and BBB rated bonds had fallen by double-digit percentages in price – even though many of them are high quality companies with a low risk of default.

She points to the fact that we are seeing investment grade companies and fallen angels pay premiums in the primary market and trading wide in the secondary market – citing the likes of Carnival and PVH as recent examples of companies they have purchased.

Commenting on PVH, the investment owner of Tommy Hilfiger and Calvin Klein, on the secondary market, Ms Isles says its double-digit online sales growth in loungewear – coupled with PVH’s operational flexibility, long-dated debt structure and significant liquidity - put it in a strong position for the future.

The focus on company resilience has meant they have not had to change the shape of the portfolio, and only one issuer of the 73 currently in their portfolio, was at a high risk of default.

Examples of that resilience include holding Enviva, which produces wood pellets used for power generation – which has its future secured through long-term contracts – or Herbalife, a direct seller of nutritional products, which has seen record volumes due to an increasing focus on health from customers.

The proof is in the performance, with the fund top of its peer group over ten years, returning 87.15 per cent compared with a sector average of 59.51 per cent. Over five years it has returned 23.6 per cent, compared with a sector average of 15.9 per cent.

It has a distribution yield of 4.7 per cent and is also attractively priced with an ongoing charges figure of 0.37 per cent.

Darius McDermott is managing director of FundCalibre