High yield bonds now look very attractive following the recent rout in global markets, according to Bill Eigen, manager of the $6.9bn JPM Income Opportunity fund, who says valuations in certain areas are now as low as they were during the global financial crisis. 
FE Trustnet readers will no doubt know of Eigen’s view on the bond market, as he has stated over recent years that it is “broken”, there will be “devastation” when interest rates start to rise and that most bond funds are “guaranteed to lose money” thanks to huge distortions created by the world’s central banks.
As a result, his JPM Income Opportunity fund (which is effectively an absolute return portfolio) has tended to have a very high weighting to cash as he has held the view that economic fundamentals are no longer reflected in the prices of fixed income assets.
FE data shows this has helped performance to some extent though, as while the Barclays Global Treasury index is down 3.66 per cent over three years, Eigen’s fund is up 2.18 per cent.
Performance of fund versus index over 3yrs
Source: FE Analytics
However, after all those bearish comments, the manager now has a very different view on the market following the recent rout in risk assets.
“It’s one of the more exciting times for the strategy right now because we have finally been graced with some real volatility that we haven’t seen in years. One of the primary aims of the fund is when there is risk worth taking, we’ll take it,” Eigen (pictured) said.
“When there isn’t risk worth taking – i.e. when volatility is very low and spreads are very tight – this fund will tend to be very defensive. It will hold a lot of cash will have more shorts than longs and not emphasise any areas of the market if everywhere is expensive.”
“That is very similar to what happened this time last year when the fund held between 65 and 70 per cent in cash. It looks very different today, particularly after last month when we deployed capital and have continued to do so.”
“Today, that cash position is about a third of the fund and that is the lowest is been quite some time.”
The main area Eigen has been buying is high yield debt and there is one major reason for that.
According to FE Analytics, thanks to factors such as China’s growth scare, falling commodity prices and uncertainty about the trajectory of interest rates in the US, the Barclays US Corporate High Yield index is down close to 10 per cent since April.
Performance of index since April 2015
Source: FE Analytics
He says this has thrown up the “single best opportunity” in bond markets since 2011 and adds that some areas are even as cheap as they were in 2008 despite the fact the economy has been growing and default rates have stayed low.
He therefore argues that certain parts of the high yield market are screaming value. This is clearly far removed from what he has said in the past, having once told FE Trustnet that he would only invest his then 56 per cent cash weighting if there were “blood on the streets”.
"The biggest fallacy in fixed income is the myth that you need to be fully invested in the market at all times. Don’t believe it. Cash is our benchmark and we keep it as dry powder to mobilise for opportunity around volatility – when spreads are blowing out, there’s blood on the streets and so on,” he said in October 2013.
However, while he makes no prediction on the future of interest rates and government bond yields, Eigen says uncertainty around rates, China and commodity prices have led to credit spreads that cannot be ignored.
“There have really been three things driving the valuations in credit spreads that I have been talking about, which are getting priced to the point where in parts of the market they were pushed wider than they were during the European debt crisis in 2011, which I find fascinating.”
“Back in 2011 you really had no growth anywhere, Europe in recession and in danger of the financial collapse. There aren’t the same stresses as in 2011 but everyone is completely obsessed with China. Every single piece of economic data, that no one used to pay any attention to, they now are.”
“What it does do is drive fear and fear drives selling and selling into markets that are less than liquid, like lower rated credit, exacerbates price moves. These markets aren’t the same places they used to be, you don’t have the same players driving liquidity.”
“The people who are driving liquidity are people like myself who are looking for extreme value in these markets before they are going to engage – and we have finally started to see that.”
The manager does warn that given the huge amounts of negativity in markets, high yield may continue to lose investors’ money over the short term. However, he thinks longer term fixed income investors have been thrown a lifeline by the spreads now on offer.
“High yield has always been an asset class that is bought and sold incorrectly by retail investors. They tend to buy when it’s performing very well – that’s exactly when you should not buy high yield, that’s when you should sell it because you are not getting paid anything to own it at that point.”
“People then tend to sell it when it starts screaming value. It means you have seen tremendous outflows from high yield over the past two years.”
He points out that some $23bn came out of US high yield in 2014 and a similar trend has emerged this year.
“Fundamentals are still reasonable in the high yield market, you’re going to see some energy defaults but you are not going to see the whole sector default. However, spreads have gone up to levels that are commensurate with the default rate basically tripling from these levels in a very short period of time – and I just can’t see that happening.”
Clearly, Eigen is talking about US high yield but it seems IA Sterling High Yield funds have also been caught out by the selling and general negativity.
While they weathered the spike in government bond yields earlier in the year, FE data shows all but one of the peer group has lost money since June. The likes of Baring High Yield, Aberdeen Global High Yield and AXA High Income are down more than 5 per cent over that time.
Performance of funds and sector in 2015
Source: FE Analytics
All told, while Eigen was concerned about most of the bond market, he thinks this is an opportunity that cannot be missed.
“We are already trading at very depressed levels in the markets we are focused on, with very high margins of safety and negative technicals – which I like to see,” he said.
“We don’t like to focus on parts of the market unless people hate them and, trust me, people hate high yield. You look at $23bn in outflows from high yield last year and about the same already this year, ETFs have had tremendous outflows, you have closed-ended funds trading at close to record discounts to NAV and some trading at their lows in 2008.”
“These kinds of things don’t happen very often and we are taking advantage of it.”
JPM Income Opportunity’s sterling hedged class was launched in February 2008. Over that time it has returned 32.03 per cent. As a point of comparison, the IA Targeted Absolute Return sector has gained 26.06 per cent over that time.
The fund has had a maximum drawdown of just 4.56 per cent and an annualised volatility of 2.71 per cent over that time.
