Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.
The high yield bond world has changed. Following the positive developments we have seen in the last 30 years, the ‘junk’ nickname – coined by Michael Milken in the 1980s and still occasionally used – is no longer justified for this asset class.
Volatility in long-dated government bonds such as US Treasuries or UK Gilts is, in some cases, greater than in high-yield bonds. Many governments are taking on ever-increasing levels of debt and doubts about the sustainability of that debt are growing. By contrast, most corporate balance sheets are quite robust and the global economy is growing steadily.
High-yield bonds are a sound asset class: the coupons provide a regular, pre-determined income stream which can boost performance if re-invested. Furthermore, the average credit quality in the high-yield sector is now much higher than it was in 2010, when I began my investment career.
In practice, we like to think of high yield as akin to defensive equity rather than to compare it against other bond segments, such as government bonds or investment grade. As long-term owners of bonds, we almost think in terms of shares, and we also closely follow the research on our listed issuers. Of course, we do not forget that in the bond market we must minimise risks rather than maximise opportunities because the upside potential is, by the very definition of the instrument, limited.
Misconceptions around drawdown and volatility
One notable trend in the modern-day high yield market is the confusion of drawdown risk (the chance of a bond’s price falling in the secondary market) and actual credit risk (the probability of permanent capital loss when a borrower cannot repay in full).
Judging underlying credit risk purely through the lens of drawdowns can be misleading. Short-term periods of market weakness can be governed by liquidity and duration considerations but longer-term outcomes correlate with credit risk.
Credit risk ultimately manifests over a full cycle – particularly through defaults – not through short-term price movements. In recent years, this phenomenon has been visible within private credit; investors initially attracted by an illiquidity premium to potential returns may now be harbouring mounting concerns over underlying loan quality, the prospect of capital loss or restrictions on asset withdrawals.
Volatility can present opportunities
Many investors have developed an obsession with volatility, and that is a key reason why private markets became so popular. Assets with lower liquidity – such as private credit – can create an impression of stronger performance and lower volatility during some bouts of market weakness. However, the illusion of price stability created by mark-to-market infrequency is only a short-term phenomenon.
Because short-term price movements do not provide a linear guide to underlying credit risk, this means that market volatility can create opportunity. The price volatility in higher quality bonds earlier this year ultimately provided an opportunity for investors to invest in bonds with better underlying business fundamentals, or to move up the capital structure without sacrificing yield.
When a sector expands so rapidly, it always involves risks, and we are seeing this with private credit currently. But I do not expect the high-yield bond market to suffer as a result.
Finding high-quality credits in listed, liquid markets
Our portfolio is the antithesis of the private credit market. We favour borrowers in liquid markets, with a preference for those whose shares are also listed. Of course, bond prices fluctuate. But investors should understand that just because there is no mark-to-market valuation for an asset, this does not mean there are no risks.
The key to unlocking the best returns from the asset class is to avoid companies that default on their debts. We target a quality bias towards the more creditworthy borrowers through a combination of fundamental research of individual corporate bonds and avoidance of thematic, cyclical sector risks.
We also believe that seeking out companies with idiosyncratic risk and avoiding large accumulations of thematic, cyclical risk is the best way to achieve good long-term outcomes within high yield. We look at global developed market high yield, which gives us a universe of over 3,000 bonds to choose from.
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Key Risks
Past performance does not predict future returns. You may get back less than you originally invested.
We recommend this fund is held long term (minimum period of 5 years). We recommend that you hold this fund as part of a diversified portfolio of investments.
The single strategy funds managed by the Fixed Income team:
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May consider environmental, social and governance ("ESG") characteristics of issuers when selecting investments for the Funds.
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May hold overseas investments that may carry a higher currency risk. They are valued by reference to their local currency which may move up or down when compared to the currency of a Fund.
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Holds Bonds. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay.
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May encounter liquidity constraints from time to time. The spread between the price you buy and sell shares will reflect the less liquid nature of the underlying holdings.
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May, under certain circumstances, invest in derivatives, but it is not intended that their use will materially affect volatility. Derivatives are used to protect against currencies, credit and interest rate moves or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions. The use of derivatives may create leverage or gearing resulting in potentially greater volatility or fluctuations in the net asset value of the Fund. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead. The use of derivative instruments that may result in higher cash levels. Cash may be deposited with several credit counterparties (e.g. international banks) or in short-dated bonds. A credit risk arises should one or more of these counterparties be unable to return the deposited cash.
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May invest in emerging markets which carries a higher risk than investment in more developed countries. This may result in higher volatility and larger drops in the value of the funds over the short term.
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May target an absolute return. There is no guarantee that an absolute return will be generated over the time period stated in the fund objective or any other time period.
The risks detailed above are reflective of the full range of single strategy funds managed by the Multi-Asset team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
Disclaimer
This material is issued by Liontrust Investment Partners LLP (2 Savoy Court, London WC2R 0EZ), authorised and regulated in the UK by the Financial Conduct Authority (FRN 518552) to undertake regulated investment business.
It should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets.
This information and analysis is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content, no representation or warranty is given, whether express or implied, by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID) and/or PRIIP/KID, which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.com or direct from Liontrust. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
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