High-yield bond fund managers expect many of the same factors that fuelled the market last year to be the focus this year, notably economic recovery, interest rate markets, low corporate default rates and new issues.
Claire McGuckin, co-manager of high-yield funds at Kames Capital, points to the US interest rate market as the key driver of high-yield corporate bonds last year, and expects its movements to continue to be the main focus in 2014.
From May to July last year, the US Treasury bond market, and to some extent the UK gilts market, corrected dramatically after the Federal Reserve suggested it might soon start ‘tapering’ its quantitative easing policy. The US Treasury bond yield widened from 1.6 per cent on May 1 2013 to 2.8 per cent by July 5.
This triggered significant outflows from the US high-yield corporate market and a fear of outflows in Europe, says Ms McGuckin, but by September, the market had largely stabilised and high-yield bonds returned to their “gradual grind tighter”.
Chris Higham, portfolio manager of Aviva Investors High Yield Bond Market fund, highlights low corporate default rates as a factor that is driving the performance of the high-yield market, along with the return of growth, zero interest rates for the past five years and investors’ hunt for yield.
“These factors combined mean that any yield is fairly compelling because there are not too many alternatives on offer,” he says.
In Europe, banks have been issuing ‘capital securities’ such as contingent convertibles (CoCos) and Additional Tier1 bonds to comply with regulators’ demands that they meet more stringent levels of capital and leverage.
This trend is providing some “quite attractive opportunities” for fixed income managers, says Owen Murfin of BlackRock’s global bond team. These instruments are typically high-yielding, with CoCos for example, offering very attractive coupons of roughly 7-8 per cent, a level that reflects their risky nature.
They are deeply subordinated and carry a coupon risk, meaning that an investor could potentially lose all their capital.
“The danger is that people will not really understand what they are buying because there are large differences between these instruments and senior bonds,” cautions Mr Murfin.
Ms McGuckin prefers the US high-yield market over Europe in terms of absolute yield. She argues the US is more mature and is more stable going forward, in spite of the US, on average, being a single B-rated index while Europe, on paper, is on average a BB index.
“The reality is that some of the underlying aggressive trends in new issuance [in Europe] have been masked by the fallen angels,” she says.
For example, Telecom Italia was relegated from investment-grade to high yield, bringing with it a huge amount of debt.
In contrast, most issuers in Europe in the past six to nine months have been smaller, B-rated companies, with single lines of business.
Ms McGuckin believes the “idiosyncratic risk”, or company specific risk in Europe is much higher than in the US because of the number of such new issuers in Europe.
