While bonds have surprised investors and managers in 2014 with relatively strong performance when most expected looming interest rate rises and an end to quantitative easing to stress fixed income markets, high yield has underperformed both government and investment grade bonds.
According to FE Analytics, the Barclays US Corporate High Yield index is up 8.72 per cent in 2014 while the Barclays US Corporate Investment Grade and the Barclays US Government indices have gained a respective 12.74 and 10.23 per cent.
Performance of indices in 2014
Source: FE Analytics
This is in contrast to the previous two years when US high yield significantly outperformed both investment grade and government bonds.
Before this high yield had only underperformed in three of the past 10 years – 2011, 2008 and 2007 – the three weakest years for global markets.
While all three areas of the market suffered from a sell-off in September and November this year, high yield has been slower to recover lost ground.
Becket says being long credit and underweight sovereigns “was not a great stance” to hold in November but he is expecting this to change.
“As we look back in the short term, this is the most depressed I have felt about our fixed interest positions since 2011, when government bond yields collapsed and corporate spreads widened,” he said.
“However, as I look forward, this is the most optimistic I have been since those low days. Spreads over treasuries on US high yield have expanded over the year and offer decent medium-term value in our view.”
“While core US high yield offers decent value, there are arguably 'once in a cycle' opportunities to exploit in the lower echelons of the credit universe.”
Over the longer term high yield has been the standout performer, gaining significant more than the ‘safer’ parts of the market.
Performance of indices over 6yrs
Source: FE Analytics
The stellar gains had led some commentators – including Becket (pictured) – to believe the market was overvalued.
“Over the last few months lower rated and smaller issues have been torched on both sides of the Atlantic, as risk aversion has set in to credit markets and marginal selling in illiquid markets triggered a collapse in prices,” he said.
“Sentiment in the US has been weakened further, as many junior oil companies' bonds have been decimated, partly as a plummeting oil price raises fears over the ability of these companies to refinance.”
Chris Iggo, chief investment officer and head of fixed income at AXA, agrees that the US high yield sector has been particularly affected because of the high proportion of this part of the bond market that energy accounts for, at around 13 per cent.
“The market index for this sector has dropped 11 per cent since early September, contributing to an overall negative return for the US high yield market over the same period. At the aggregate level, US high yield has underperformed European high yield bonds and US equities because of this concentration of energy-related borrowers in the index,” he said.
“While non-energy sectors have fared better, the drag on overall performance from energy has left the high yield market languishing with a yield to worst of 6.4 per cent.”
Becket says there is a similar situation in European high yield, where he says investors rushed to buy “anything with a yield” including higher quality credits. However, they all but avoided any riskier, lower rated bonds, although he warns the market is more fragile.
“This has meant that relative spreads are exceptionally wide and many lower rated credits are trading at almost distressed levels. Therefore if you can find the right manager to buy the right bonds, there should be a sensational buying opportunity on offer, unless you are a fully signed up member of the ‘Economic Ice Age/ Financial Armageddon’ club,” he said.
“Of course, whether it is in the US or Europe, it could take a while for prices to recover, but given you are being paid handsomely to wait for the recovery, this seems an excellent medium term opportunity.”
However, Becket says risks remain in this particular part of fixed interest with illiquidity, economic uncertainty and investor confidence “brittle” but relatively speaking it is more attractive than other parts of the bond market.
“Given we think there will be a continuation of the low rate, low inflation, low yield and low default environment, we would certainly favour them over UK gilts, where investors have to satisfy themselves with a yield of 2 per cent on the 10-year,” the CIO said.
