High yield to run out of steam in 2013
Fidelity’s Peter Khan has positioned his portfolio to protect himself from an increasing default rate within the sector.
Investors should not expect the high yield bond sector to repeat this year’s excellent performance in 2013, according to Peter Khan (pictured)
, manager of the Fidelity Global High Yield
Data from FE Analytics
shows that the IMA High Yield sector has returned 14.88 per cent in the year-to-date, outperforming all of the other bond sectors; however, Khan says this momentum could soon run out of steam.
The manager is overweight the higher end of the market – BB and B rated – and significantly underweight the CCC end, as he anticipates a squeeze at the lower grades where default rates have been at record lows.
"We are already thinking about the stage when the level of risk rises and volatility increases and the higher-grade assets start to perform, that’s where you should see us outperform substantially," he said.
"We think global default rates will rise to 4 per cent as a base-case scenario, barring unforeseen scenarios in Europe, and there is still value in such a market."
"The bear case of 8 per cent is less likely than it was before Mario Draghi’s announcement of the OMT plan."
Khan has recently taken profits that resulted from the recent optimism in Europe, believing the positivity will soon fade.
"We are in the process of reducing our European positions and are allocating to more global names and businesses that are exposed to improving economies and business profiles," he added.
The lack of liquidity in the market is also a concern for Khan, with most dealers running at 40 per cent capacity compared with the 08/09 period.
"We are running liquidity cushions at higher levels than we normally would with yields and spreads where they are today," he continued.
Khan says that this is still a good time to invest in the high yield market, with a swiftly expanding universe of companies from which to choose. The growth has been particularly high in emerging markets and Europe.
The manager believes this trend is being driven by both positive reasons – companies seeking to diversify their credit lines away from banks – and negative ones – low interest rates and an environment of "financial repression" driving a search for yield.
He notes that balance sheets have become much stronger in recent years, but says that companies may be about to start investing the money that they have saved.
"We may be approaching an inflexion point where more normal spreads take over, driving more issuance."
Fidelity Global High Yield was launched in March this year and data from FE Analytics
shows it has outperformed its sector since then.
Performance of fund vs sector since March 2012
Source: FE Analytics
The £14m fund has a minimum investment of £1,000 and a total expense ratio (TER) of 1.48 per cent.
Khan says that Fidelity’s analyst team looks for stocks in which it has a high conviction, with reasonable volatility levels and good cash flow.
If it is a financial institution then the management team looks for clear exit routes.
He says that strong risk-adjusted returns make the sector very attractive to investors, with volatility that is lower than equities but with comparable returns.