A buying opportunity has opened up in riskier fixed income assets such as US high yield and emerging market debt, according to M&G’s Jim Leaviss (pictured). 
The manager of the £1.1bn M&G Global Macro Bond fund believes emerging market debt (EMD), US high yield and European investment grade credit are all showing good value as technicals and fundamentals have become detached.
The manager notes that his fund is “totally flexible” and that he can “go anywhere” in terms of fixed income, but currently sees the biggest opportunities outside of the perceived safety of government bonds.
“We could be 100 per cent invested in government bonds if that's where we thought the value was. The same for investment grade credit, high yield or emerging market debt. Inflation-linked bonds are something that I think are going to be increasingly interesting to us in the next couple of years – especially for a sterling investor,” he said.
According to FE Analytics, investors have preferred ‘safer’ fixed income exposure in 2016 so far in what has been a bearish first three months for markets. This is shown below with the stronger performance of the gilt market than the ‘riskier’ credit market.
Performance of indices in 2016
Source: FE Analytics
However Leaviss, who was speaking at the FE Trustnet Select Fixed Income event last week, says there is reason to believe several areas of the global credit market are oversold with implied default rates substantially higher than is likely and therefore offering decent value.
“We really want to have an overweight in credit, having taken down our credit exposure a year and a half ago. We are now have significant exposure to investment grade credit and to high yield bonds. We want to take risk again in emerging markets,” he said.
“There was a time when we had zero exposure to emerging market debt. [However] we have pulled together the fundamentals and technicals and allocated appropriately. It's a risk-on phase for us at the moment for a number of reasons.”
“I have been very bearish on emerging markets for a very long time. Selectively it is now time to start buying back into the asset class and we have now taken a 20 per cent exposure to emerging market currency and emerging market bonds.”
Given heighted volatility and equity market weakness, EMD has been an out-of-favour area of the market some time. This is shown in the graph below, where over the past three years the average portfolio in the IA Global Emerging Market Bond sector is down 5.51 per cent while the Markitt IBOXX Overall index has gained 14.60 per cent.
Performance of sector and index in 2016
Source: FE Analytics
Leaviss is also increasing exposure to the US high yield market, where he says energy-related woes from the low oil price has irrationally turned many away from the market as a whole.
“We are buying US long-dated corporate bonds. The market is pricing in a 4 per cent default rate for BBB-rated in the US. Is this likely, that they will be 10 times higher than they have been on average throughout history given the US is not in recession?”
“Implied default rates for B-rated credit are 10 per cent. The overall default rate for high yield bonds at the moment is 4.3 percent. However it all about energy and we don't want to go anywhere near them, they are worthless.”
“If you strip [energy-related bonds] out of the global default rate and the underlying global high yield default rate is 2.4 per cent so [almost] exactly half what B-rated was historically.”
He says the energy credit is nearly all from shale oil producers, some of whom will go bust as the price squeeze on the ‘avant-guard’ form of oil and gas extraction makes their business economically unviable.
“If you strip out further and purely look at US high yield default rates over the past 12 months, it is 1.3 per cent. I am under no illusions that those default rates are going to rise… they can’t really fall much further than we are right now but the market is pricing in 10 per cent for defaults for Bs and 7 to 6 per cent for BBs”
“I think there is a lot in the price. If you are selective and you don't buy the energy sector, you're are diversified then you can really outperform government bonds by owning high yield and investment grade bonds.”
The manager is also expecting European investment grade credit to rally as the European Central Bank (ECB) increases its stimulus programme in reach by purchasing non-bank credit.
“The big technical factor that is going to hit credit is the ECB. They are going to start buying corporate bonds and for those of us in the corporate bond market when the BOE where buying corporate bonds as parts of its asset purchase programme... it's incredibly powerful thing for driving spreads lower.”
Leaviss has headed the M&G Global Macro Bond fund since 1999. It is top quartile in the IA Global Bonds sector over five and 10 years but is second quartile over three and one-year periods.
Performance of fund and sector over 3yrs
Source: FE Analytics
