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High tension

Some managers believe it could be time to consider a return to high-yield bonds. Chris Salih reports

Advisers and fund managers are still divided as to whether there is a buying opportunity in high-yield bonds, following recent poor performance in the sector.

Many bond managers have taken a punt on the sector in recent months, only to be burned as concerns over the global economy deepen.

The average high-yield bond fund has fallen by 7.8 per cent in the past three months. Strategic bonds have also been bitten and some higher-yielding funds, such as the Invesco Perpetual tactical bond, fell by more than 9 per cent to August 26.

However, with spreads now in the region of 750 to 800 basis points, is there an opportunity for investors to plough in?

Dennehy Weller managing director Brian Dennehy says high-yield bonds tend to be closely correlated to stockmarkets and, given the current state of the economy, it is difficult to justify investing in them at this time.

He says: “Yield spreads may widen further yet and we will look for maximum dislocation in the stock-market before buying in, just as we saw in November 2008, from which point high yield bonds began recovering a few months ahead of the stockmarket.”

In the midst of the Lehman Brothers’ crisis, spreads went from 1,000 to 3,000bps, according to the Merrill Lynch sterling high-yield index.
However, not everyone shares Dennehy’s view. M&G fund manager Richard Woolnough upped high yield exposure in the M&G corporate, optimal income and strategic corporate funds to their highestever levels in August.

Woolnough says current spreads are “too pessimistic”, raising highyield exposure from 6 to 8 per cent in the corporate bond fund, from 39 to 42 per cent in the optimal income fund and from 10 to 14 per cent in the strategic corporate fund.

Kames Capital high-yield bond fund manager Philip Milburn says the market needs to fall by around 10 per cent – pushing highyield spreads to the 1,000-1,100 mark – before it would appear attractive.

He says: “Barring Lehman’s, 1,100 has been seen as the cheapest point in the cycle for high-yield bonds. It will be a screaming buy at that point.

“We are defensively positioned but slowly moving into other areas. We have a 5 per cent cash position and two hedges of 5 per cent each to further reduce risk. One is against senior financials in case the sovereign crisis worsens and the second is aimed at macro weakness, adding some protection against our exposure to emerging markets.”

Strategic bonds, which have the ability to switch into different bonds according to market conditions, have also suffered, with many jumping the gun in the belief that there has been a buying opportunity in the sector.

Henderson strategic bond fund manager John Pattullo admits his team has got the asset allocation wrong on high yield over one month, with too much invested in the sector, but stresses his fund does not invest over that timeframe.

He has 40 per cent in high-yield industrials and 25 per cent in financials, which he says are paying an equivalent to high yield, despite being rated as investment-grade.

He says: “Our view is that high yield is a reasonable place to be and we have a strong track record over the long term. We have sold a bit down and protected the portfolio with derivatives.”

Pattullo’s team has concentrated on the quality end of the market, preferring to invest in BB/ B-rated high-yield bonds.

He says: “We have focused on less cyclical names. I think it will get worse in the short term as there are more buyers than sellers. High yield is an interesting place to be but we are upping the quality in the market.”

Jupiter strategic bond fund manager Ariel Bezalel agrees volatility could get worse, especially with the sovereign crisis in Europe.

Bezalel invests 45 per cent in high yield, with the majority also in the B/BB ratings scale. He says: “There are opportunities in high yield but you have to be very sector-specific. You can get yields of 7 to 9 per cent in quality high yield. If equity markets go lower, which we think they will, so will high yield, and it will reach spreads of 1,000-plus.

“We have a struggling banking system and that will feed through to bond markets. Things will get worse before they get better.”

Hargreaves Lansdown head of research Mark Dampier says: “There are opportunities but with the problems in Europe such an unknown, pulling the trigger on investing in high yield is difficult at this stage. If I were to go in, it would be with someone like Richard Woolnough, who invests at the quality end of that market and steers clear of financials.”

Bestinvest senior research analyst Ben Seager-Scott thinks high yield looks attractive on a short-term basis. He says: “It is important to remember there is less duration in high yield while default risks in the market are still low. I would recommended investing 5 to 6 per cent of a portfolio in high yield at present.”


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