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The hunt for safe havens has seen investors pile out of high yield bonds, says Joanne Ellul, but these assets remain good diversifiers if the risk is well managed

High yield bond funds suffered a sell-off in the second half of last year but managers say they can control risk in their portfolios by limiting exposure to the EU.

There were record inflows of retail money into fixed income in January as investors flocked to safe-haven assets. The sector saw £671m of net retail sales in the month, the highest level since October 2010, according to statistics from the IMA.

Corporate bonds was the most popular fixed income IMA sector, with £302m of net retail sales, compared to £42m in high yield.

Sales of pure high yield may not be strong but strategic bonds, which recorded £128m of net retail sales in January, could be acting as a source of high yield for investors.

As high-yield funds are heavily correlated to the stockmarket, pure high- yield bonds may not offer good diversification from equities in a portfolio.

Hargreaves Lansdown senior analyst Meera Patel says: “Strategic bond funds have the flexibility to move around the entire bond spectrum and the risk of the fund will vary over time but there will be exposure to where there is value in the market.

“The risk of equities is similar to that of high-yield bonds but for clients that are prepared to take on risk, these type of bonds can offer high income as well as capital growth in these undervalued bonds.”

Patel says once signs begin to emerge that the eurozone crisis is approaching a long- term resolution, as opposed to the European Central Bank’s short-term injections of liquidity, high-yield managers will make money from the stockmarket recovery.

Some managers have been looking outside the EU for exposure to the high yield market.

Kames Capital fund manager Melanie Mitchell, who runs the £559m Kames high yield bond, increased the fund’s US high yield position in the middle of last year, from 25 per cent to 32 per cent.

She says: “At the end of last year, we saw a sell- off in European high yield. We anticipated this and wanted to protect the fund from the ongoing problems in Europe.”

In December, Mitchell slowly began building up European high yield to take advantage of a potential upturn in the market. She added 3 per cent to European high yield to increase the fund’s exposure from 35 to 38 per cent.

She says: “The reversal of our position is an attempt to catch the oversold position in European bonds.”

Scottish Widows Investment Partnership head of European high yield Steven Logan, who manages the £1.4bn Swip high yield bond fund, says US high yield performed much stronger than EU high yield in 2011.

Logan says: “The 2011 performance was pretty disappointing for European high yield, which was down by 2.6 per cent compared to US high yield, up by 4.4 per cent. There was volatility in August that the European high-yield market could not recover from.”

Market volatility remains a risk to European high yield and managers have had to manage this risk within their portfolios.

Logan says: “If Europe holds it together through such policies as the ECB’s long-term refinancing operations, Europe will muddle along in terms of growth and high yield will offer attractive returns. My worry is that we may have a return of the European sovereign debt problems.

“We are running a fully invested mandate to take part in the stockmarket rally but we are also overweight defensive and quality high yield companies.”

Logan says the Swip high-yield bond fund is invested in big businesses such as German tyre manufacturer Continental AG and cement producer HeidelbergCement, which he says generate high yields and are resilient to sluggish economic growth.

Bestinvest senior analyst Ben Seager-Scott says: “High yield is a good diversifier in an investor’s portfolio, as it is less sensitive to interest movements and has a high coupon payment.”

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