High yield credit has performed well recently as investors have been pushed up the risk spectrum as a result of the quantitative easing programmes being implemented across the developed world.
According to FE Analytics, the average fund in the IMA Sterling High Yield sector has returned more than 100 per cent over five years, for instance.
Performance of sector over 5yrs
Source: FE Analytics
However Sparks, who is head of US fixed income at Schroders and manager of the Schroder ISF Global High Yield fund, says that investors who still want exposure to the asset class are better off waiting for a correction.
Although the manager is not concerned about higher default rates, he says that with spreads having tightened so much and yields now so low compared with historical levels, investors should expect volatility.
"I do not think high yield, or many fixed income assets, are cheap right now. In my opinion, there will be better buying opportunities," Sparks said.
His thoughts echo those of Invesco Perpetual’s Paul Read, who recently told FE Trustnet that that the bull run in high yield is over, because there is virtually no capital upside left in lower-rated credit.
Sparks continued: "Right now, you could say that high yield is in a fair value range. However, we are close to risky levels and now is a time to trim exposure as there will be a better time to buy."
"Given the current yields of around 5 per cent, we have come to the conclusion that high yield is not overly compelling. Though it is by no means high risk, it makes sense to be patient and wait for more attractive valuations," he added.
The manager says that investors should wait until 2014. However, he adds that they should use any upcoming corrections as a chance to buy into the asset class, saying there should be plenty of volatility in the medium-term.
He believes that any correction next year will likely be due to current macro-economic headwinds.
"I think the major risk will be event risk," he said.
"Possible QE tapering and the US fiscal situation are going to be key factors next year, or it could even be a recession; but I really don’t think that is likely. Nevertheless, short-term corrections provide attractive entry points as they can create better conditions for investors."
"Valuations can reset to levels where price appreciation is possible, as we saw after the June correction," he added.
The manager is hoping for a correction in the yields of BB-rated bonds, which he says would make these assets look attractive compared with lower rated credit.
Sparks has managed the $3.1bn Schroder ISF Global High Yield fund since its launch in April 2004.
Our data shows it is a top-quartile performer in the IMA Global Bonds sector over this time with returns of 104.55 per cent, beating the sector average by more than 40 percentage points.
Performance of fund vs index since April 2004
Source: FE Analytics
The fund also boasts top-quartile returns over one, three and five years. It has performed consistently well since its launch, only falling short of the sector in three of the last nine discrete calendar years.
The fund also has an above-average yield of more than 6 per cent.
Given the manager’s concerns over the immediate outlook for high yield, he has started to take steps to de-risk his portfolio.
"Firstly, we have been focusing on companies where the management team’s interests are still aligned with bondholders," Sparks explained.
The manager says he has been selling out of companies that have recently taken part in M&A or capex, while maintaining exposure to companies that are still de-leveraging, in the process of an IPO or that he feels may be upgraded by the credit agencies.
He has also been reducing his duration and moving into the more liquid areas of high yield.
That has been at the expense of his emerging market debt exposure, however, as he is concerned that investors in the asset class are likely to be hit by further capital losses over the next year or so.
"We have trimmed some emerging market exposure into the fall bounce. Our position is currently only 5 per cent, and that is because of our concerns surrounding rising rates and recent outflows," he added.
The Schroder ISF Global High Yield fund has an ongoing charges figure (OCF) of 1.29 per cent and requires a minimum investment of $1,000.
Click here to learn more about bonds, with the FE Trustnet guide to fixed interest.
