Skip to the content

How should investors react to the high-yield sell-off?

08 August 2014

The high-yield bond market has stuttered, but some funds in the sector could still be appropriate for cautious investors.

By Gary Jackson,

News Editor, FE Trustnet

High-yield bonds have been hit by geo-political worries and a fall in market liquidity, leaving investors questioning how they should be playing this area of the market.

FE Analytics shows the BofA ML Sterling High Yield Total Return index has dropped 0.98 per cent over the past month, underperforming the Barclays High Yield index’s 0.16 per cent fall.

Things could be about to get a lot worse. On a worldwide basis, data from EPFR Global shows high-yield bond funds witnessed billions of dollars in net outflows in July.

Performance of indices over 1 month

ALT_TAG

Source: FE Analytics

Sentiment towards the asset class has been damaged by the greater likelihood of a rate rises by the Bank of England and Federal Reserve, risk aversion caused by the conflicts in Ukraine and Gaza, and a fall in high-yield liquidity.

The asset class has had a stellar run in recent years, delivering equity like returns with significantly less volatility.

With yields now at very low levels, it’s little wonder many investors are looking to take profits.

Performance of sectors over 5yrs


ALT_TAG

Source: FE Analytics


Mark Holman (pictured), managing partner at TwentyFour Asset Management, points out that the yield on the UK high-yield index is now higher than it was at the start of the year, thereby erasing all of the asset class’ mark to market gains of 2014 so far.

ALT_TAG “We have commented on many occasions on the topic of liquidity, but rarely has it been this poor,” he said.

“Any reasonably sized fund looking to materially change their position in credit bonds would have no chance; their only route to reducing risk would be through the use of derivatives. Fortunately these remain very liquid and therefore are a highly useful tool in these market conditions.”

Towry’s head of investment Andrew Wilson says interest rate rises now look “inevitable” in the UK and the US, adding that the Bank of England could move by the end of the year. However, he says this does not necessitate an immediate move away from high-yield.

“If the economy is strengthening, then corporate and high-yield bonds can still perform well for a bit, even with rates rising. Their yields will need to stay competitive, however,” he said.

“You should ensure you maintain flexibility in your investments by picking bond fund managers who target areas linked less strongly to the underlying base rate.”

Fund ratings consultancy Square Mile, a strategic partner of FE, has two top-rated high-yield bond funds in its Academy of Funds which it says are appropriate for defensive investors – Threadneedle High Yield Bond and Baring High Yield Bond.

Barrie Whitman and David Backhouse's £815.2m Threadneedle High Yield Bond fund is highlighted as a portfolio that tends to outperform when the European sub-investment grade debt market is falling and lag when it is rising.

“This fund is run by a highly experienced management team who have proven themselves capable of managing sub-investment grade bonds over various market conditions,” Square Mile said.

“There tends to be a focus on avoiding capital loss over the longer term, although the managers have still generated a relatively high and stable level of income over most of the fund's life.”

FE Analytics shows Threadneedle High Yield Bond defended investors’ capital better than its peers in the aftermath of 2013’s taper tantrum, falling 3.59 per cent between 22 May and 25 June compared with the sector’s average decline of 4.16 per cent.

The fund, which has ongoing charges of 0.74 per cent, has returned 25.40 per cent over the past three years, putting it in the second quartile of the IMA Sterling High Yield Bond sector.

Performance of fund vs sector over 3yrs


ALT_TAG

Source: FE Analytics

Square Mile also tips Ece Ugurtas’ £719.4m Baring High Yield Bond fund as a possible option for defensive investors, owing to its top-down macroeconomic analysis.

The fund, which invests in high-yield across the US, Europe and emerging markets, underperformed the sector during the taper tantrum, which could reflect the fact it was holding more than 15 per cent of its portfolio in emerging market debt.


Square Mile’s analysts said: “The thoughtful process, and in particular the emphasis on top-down macroeconomic scenarios, sets this fund apart from its competitors.”

“We believe that this approach results in a fund which is less volatile than some of its competitors and can flourish in a number of different macroeconomic environments, producing a steady income and with a focus on capital preservation over the longer term.”

Baring High Yield Bond, which has performed roughly in line with the sector over three years, has ongoing charges of 1.30 per cent.

Performance of fund vs sector over 3yrs


ALT_TAG

Source: FE Analytics

Ben Gutteridge (pictured), head of fund research at Brewin Dolphin, does not see the recent sell-off in high yield as being a sign of “something more worrying”.ALT_TAG

“With economic conditions improving, bank lending criteria loosening, and short rates fairly well anchored, we are doubtful investors will sacrifice the yield on offer in lower quality bonds and move into cash or government bonds,” he said.

“We are also sceptical that holders of high yield bonds would be motivated to switch into equities, given the pervasive overweight that already exists in this asset class.”

However, Gutteridge concedes that now is probably not the time to add more to high-yield, given the scale of outflows coming from the asset class and the hawkish tone of some of the Fed’s policymakers.

ALT_TAG

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.