Mitchell (pictured), who runs the £1.4bn Kames High Yield Bond fund, says she is avoiding higher-yield areas of the market as prices are now overly stretched and a pick-up in volatility is inevitable.
The manager is baffled as to why market sentiment is so high as she does not see any support in fundamentals for the current rally. She is maintaining a relatively defensive portfolio. "I have had the view for the last few months that markets have to sell off, but the way they have rallied I would have to tell you I am wrong. However, markets can be wrong and history has proven that," she said.
"We had a very long meeting yesterday discussing whether we are just scared bears and whether it is actually OK out there to put our heads outside of the cage."
"However, looking at risk asset valuations where they are now, I don’t think you are getting paid enough for the risks involved. Volatility is at very, very low levels at the moment due to the wall of money for the central banks."
"That financial repression has contributed to squeeze prices ever higher, but if the unexpected were to happen, then that volatility would undoubtedly pick up. It’s not just the default risk in high yield, you have to wear the volatility risk."
"I have to be able to justify buying risk assets at the moment, because if there was a risk-off day in the market, nothing fundamentally changes but volatility comes into play."
"With volatility at such low levels, it’s like with interest rates, they can only get higher," she added.
Mitchell said the ongoing European saga will be one of the major contributors to any market sell-off.
"European politics is absolutely top of my list," she said.
"That concern has picked up in the last months with the Italian elections. Though I wouldn’t say the vote has failed, the alarm clocks were close to going off. Despite that, markets were very sanguine about it and just carried on."
"There was an attempt to sell off but it only lasted a little while and wasn’t very high conviction – markets just brushed it off."
"Though a failed Italian government wouldn’t dramatically change the European economy, it would create headline risk."
"The other easy thing to see is the increasingly weak European economic data, for instance France’s statistics are worryingly weak. When you see things like 25 per cent unemployment in Spain, Europe can possibly weather that."
"But now you are seeing really important economies like France that only has a very modest PMI. That rippling affect into the more robust economies is something that really concerns me."
"Then there is the obvious elephant in the room: Cyprus. That is scarily alarming and though they reached an 11th-hour agreement, it seems to be a return to the bad old days of one politician saying one thing and another saying something completely different."
Mitchell currently runs two portfolios: Kames High Yield Bond and the five crown-rated FSA offshore recognised Kames High Yield Global Bond fund. Both of these are co-managed by Philip Milburn.
According to FE Analytics, Kames High Yield Bond is a top-quartile performer in the IMA Sterling High Yield sector over three and five years, while her FSA offshore-recognised fund has outperformed its peers since she took over in 2007.
During her career running funds, Mitchell has returned 105.97 per cent while her peer group composite has made 76.85 per cent.
Performance of manager vs peers since Nov 2007
Source: FE Analytics
Mitchell says it is necessary to take a highly selective, bottom-up approach to investing in high yield credit, as otherwise the consequences can be dire.
"Within high yield, I do think you get paid for risk/return if you take due diligence with your stock selection," she said.
"Those who ignore market dispersions will find themselves in a bit of a mess this year, as I think markets will wake up and smell the coffee."
"I want something that will pay for the risk I am taking, so if that means I need to buy something that is yielding 6 per cent instead of 8 per cent, so be it."
Within the stock-selection process she uses, Mitchell says she is constantly looking for risk/return opportunities regarding possible default, liquidity concerns and volatility.
"We very much have the investment philosophy that we endeavour to marry risk with reward – every risk has its price," she said.
"A CCC rated bond should be cheaper than a BBB rated one, but we have to make sure we are adequately compensated for the risks and in the CCC sector it is becoming increasingly tight and I simply don’t think you are being paid enough for that risk."
"The sort of obvious risk with high yield is the chance of default, but the other major risks in the CCC market are illiquidity risk and volatility risk."
Mitchell says she has positioned her Kames High Yield Bond fund defensively. It is currently made up of higher-rated credit and non-cyclical stocks such as telecoms and healthcare.
She believes peripheral bonds are too expensive so she prefers to have minimal exposure to these regions. However, she holds a few bonds issued by multi-national Italian companies.
The fund currently has a 43.04 per cent weighting to B rated credit, 39.06 per cent in BB, 8.44 per cent in BBB and just 3.70 per cent in CCC credit.
Kames High Yield Bond is currently yielding 5.07 per cent and has an ongoing charges fee (OCF) of 1.3 per cent. It requires a minimum investment of £500.