The hunt for yield has been tough in recent years with demand from investors ramping up in the fixed income space, prompting bond yields to fall to historic lows. However, according to these managers a temporary rout in the oil price – which has battered the US energy sector – has opened up a significant opportunity in US high yield debt.
According to FE Analytics, the oil price plunge was accompanied by a relatively flat period for US high yield debt, as shown in the graph below, despite a generally strong performance for bond markets.
Performance of indices over 6 months
Source: FE Analytics
Ongoing political strife in Europe and continued pressure on US energy producers from the lower oil price will drive further volatility in high yield bonds in 2015, according to Newton fixed income managers Sebastien Poulin and Khuram Sharih, who add that this will create some attractive investment opportunities in the high yield sector.
They also believe US high yield momentum is likely to rise as bid activity increases and the demand for the asset class picks up.
Stefan Isaacs and James Tomlins, co-managers of the £1.2bn M&G Global High Yield Bond fund, say the US high yield bond market has become very attractive since the oil price fall in the second half of last year, making it look cheap on both an absolute and a relative basis.
“Following a sell-off in the closing stages of 2014, and driven in part by a re-pricing of the energy sector in the wake of steep oil price falls, the global high yield bond market currently yields around 6.7 per cent – up from a low of around 5 per cent last June,” they said.
“Looking beyond the near-term uncertainty caused by the drop in oil prices, high yield fundamentals remain sound. Lower oil prices will ultimately provide a boost to the consumer and should be a net positive for the economy, as well as for the majority of high yield businesses.”
The pair has steadily increased allocation to the US in recent months, making it the fund’s largest single country exposure at more than 40 per cent of assets compared with 15 per cent two years ago.
Phil Milburn, who heads up the £1.5bn Kames High Yield Bond fund, agrees that US high yield bonds have become more attractive than European equivalent debt of late.
“Whilst Europe started 2015 strongly the US has overtaken in February driven by a rebound in energy sector bonds and continuing strong economic data” he said.
“The announcement of [the] European Central Bank’s quantitative easing had a positive impact in January, the fact is the US has stronger credit to invest in offering more attractive yields.”
Milburn, who runs the fund alongside co-manager Claire McGuckin, says a combination of factors including attractive yields and stronger economic growth makes the US a better opportunity for income-hungry investors this year than elsewhere.
“Firstly, valuations are more attractive for US debt now, with a yield to worst of 6.1 per cent versus just 3.8 per cent in Europe. We think, with the yields available, we could make between 5 to 8 per cent this year by investing in US high yield,” the manager said.
“Simply by playing the carry trade, US high yield should deliver an additional 0.2 per cent per month versus Europe this year, given the starting position of both regions in January,”
“Then you have to consider the underlying strength of the two economies. This year is about returning to fundamentals, and the US economy is currently growing much faster than Europe.”
The US economy expanded by 2.6 per cent in the fourth quarter of last year whereas the eurozone was stagnant at best.
However, Milburn says the strong US growth numbers are double-edged for bond investors as it also means the US Federal Reserve will under greater scrutiny to raise rates, while with the ECB’s monthly purchasing of securities will be ongoing. But he says a lack of inflation in the US will mean slowly rising rates.
“The scale of any rise will be minimal and by using US Treasury futures we can hedge the rate sensitivity of some of the longer-dated bonds in the fund,” he said.
“Given we expect central bank policy to finally diverge this year, 2015 will be volatile and being able to trade without the fear liquidity could vanish will become even more important, The US offers better liquidity at present and therefore looks more attractive on this basis.”