Buying into both high yield bonds and loans is one of the most lucrative and efficient ways to generate income in today’s challenging market environment, according to Eugene Philalithis (pictured). 
The manager, who runs the four crown-rated Fidelity Multi Asset Income fund, says that the asset class has provided the largest positive contribution to the portfolio over the last year to the end of April, followed by investment grade bonds and infrastructure.
High yield seemed to increase in popularity last year during the hunt for income, with many investors believing the only way to gain an attractive yield was to climb higher up the risk spectrum due very loose monetary policies over recent years.
In an article published in September last year, JP Morgan’s Bill Eigen said that investors should turn to high yield credit because of the resilience they have shown in previous rate hikes and because of the increased volatility of traditionally ‘safe’ income assets such as government bonds.
“Investors seeking fixed income opportunity must take into account today’s regime of ultra-low global yields and weak market liquidity,” he said. “With the Federal Reserve moving towards an interest rate hike and the dramatic reduction in trading capacity, investors need to redefine what constitutes value and safety as well as when and how to deploy capital into markets distorted by multiple rounds of quantitative easing.”
However, the asset class fell out of favour at the start of 2016 due to an increase in the number of company defaults (thanks to oil price decline) and fears that the US could slip into a recession.
Given the choppy, sideways behaviour of markets so far this year and the high levels of geopolitical uncertainty (caused by the impending EU referendum and the US presidential election), many investors have returned to more traditional fixed income holdings to minimise risk.
In fact, since the start of the year, the IA UK Gilts sector has more than doubled the performance of the FTSE 100 index and has outperformed the IA Sterling High Yield sector by 2.84 percentage points with a total return of 7.39 per cent.
Performance of sectors vs index in 2016
Source: FE Analytics
In an article published on Wednesday, FE Alpha Manager David Coombs told FE Trustnet that he has virtually no exposure to high yield fixed income and believes that lower-risk bonds are likely to fare better in the event of a Brexit.
“If we do leave on the 23rd, I suspect gilt yields will fall further and you’ll make more money from bonds, or certainly the quality end of the investment grade market. High yield could sell off,” he warned.
Despite this, Philalithis says that the asset class remains a strong prospect for investors seeking income. The manager and his team focus on separate regions when selecting high yield holdings as opposed to looking at the global high yield bond sector as a whole.
For instance, Philalithis preferred European and Asian high yield during the latter half of last year, but now believes that Europe and the US offer the most attractive prospects.
“We get quite a lot of questions regarding the outlook for high yield and we think we’re in an environment where high yield bonds are still attractive, they’re paying an attractive level of income and we don’t think we’re going into a default cycle,” he said.
“The one exception from a sector perspective is the US energy sector which is under stress but, given the rebound in the price of oil, that default risk has come down significantly, at least for the foreseeable future.”
“We’re allocating more of our regional high yield to Europe and the US. One of the key things we look at is the maturity wall – how many outstanding high yield bonds are maturing and need to be refinanced.”
The manager says that the US market is the region that boasts the most favourable maturity wall and has a very low number of outstanding maturities, whereas Asia is now the region with the highest amount of outstanding debt.
He points out that, so long as investors consider these factors and are selective in terms of where they look for high yield opportunities, they should be able to bolster both the growth and income prospects for their portfolio.
“We are quite focused on [maturity walls] because a lot of companies need to refinance, but, given the levels of volatility we’ve seen since the beginning of the year we’ve seen a big drop in issuance which means that, with the search for yield still strong, there is demand for income and there should be support for the asset class,” he explained.
Another asset class that Philalithis is positive on is loans, despite the fact they provided the largest negative contribution to the portfolio over the last year. In fact, if selected carefully, the manager says they can even provide greater benefits than high yield holdings.
“Compared to high yield, loans’ returns in the US offer similar levels of return over time but with a much lower volatility,” he said.
“They have very little interest rate risk because the income is floating rate so, especially in the US market, if rates do rise that floating rate will mean the income increases from those assets as well.”
“We take diversified exposure [to high yield and to loans] through specialised managers who invest in these asset classes and can successfully choose the right credit.”
Since Philalithis took to the helm of the Fidelity Multi Asset Income fund in 2013, it has provided a total return of 13.33 per cent, outperforming its average peer by 6.12 percentage points.
Performance of fund vs sector under Philalithis
Source: FE Analytics
It has a clean ongoing charges figure of 1.13 per cent and yields 3.09 per cent.
