Asset Management

Returns On High Yield Bonds Set To Continue in 2013 - Baring Asset Management

Chrissy Coleman Asia Correspondent Hong Kong 23 April 2013

Returns On High Yield Bonds Set To Continue in 2013 - Baring Asset Management

In midst of concerns about the fixed income market overheating, Baring Asset Management has said 2013 looks like a good year for high yield bonds and believes an improving macroeconomic background supports this outlook.

High yield bonds continued to perform well in the first quarter of 2013 and the Bank of America Merrill Lynch Global High Yield Index has now generated a total return of 13.2 per cent in US dollar terms over the 12 months to the end of March, said Baring Asset Management in a report.

At the regional level, the ongoing resilience of the US economy – despite fiscal tightening – has seen the US high yield market outperforming in recent months. In contrast, European high yield has been a relative laggard, with a weak growth outlook, the inconclusive Italian election result and the banking crisis in Cyprus all impacting upon investor sentiment, the report said.

“In our view, high yield bonds look set to continue to deliver investors attractive returns over the rest of 2013. Central to this view is our belief that the asset class is one of the major beneficiaries of an improving macroeconomic backdrop and the accommodative monetary policy implemented by central banks globally,” Ece Ugurtas, investment manager, Baring High Yield Bond Fund, said.

“Furthermore, high yield default rates remain low by historical standards – just 2.6 per cent as at the end of 2012 according to Moody’s – as high yield corporates continue to experience favourable conditions. A low interest rate environment is enabling firms to refinance existing debt at historically low levels and this is in turn is encouraging prudent management of balance sheets,” Ugurtas continued.

Demand remains strong

Given the strong fundamentals and income-generating ability of the asset class, investor demand for high yield bonds remains strong. Indeed, high yield is one of the few areas of the fixed income universe which offers investors a relatively high level of income in what is a low yielding environment globally. As at the end of March 2013, high yield bonds, as measured by the Bank of America Merrill Lynch Global High Yield Index, were yielding 6.3 per cent. This compares to just 1.9 per cent from 10 year US government bonds, for example, the report said.

“Looking ahead, we see further opportunity for the yield spread between high yield and government bonds to tighten, although we expect returns from the asset class in 2013 to be mainly driven by income gains,” Ugurtas said.

“In terms of our investment strategy, we maintain a clear preference for high yield credits in the US and selected emerging markets. In the case of the US, we believe the pro-growth policies of the Federal Reserve will underpin economic growth and corporate profitability and we expect this to support the high yield bond market,” he added.

Emerging markets

According to the report, emerging market high yield corporates also offer some interesting opportunities, given that bonds in this area typically offer a higher yield than similarly rated credits in the developed world, but with lower levels of issuer debt and improving corporate governance. Barings also said it recognises that emerging market central banks generally have more scope to introduce pro-growth policies to support economic activity as and when required.

At the sector level, the firm remain cautious on banks and have no exposure given the “sector’s well documented structural problems”. The banking sector has also been the most volatile area of the high yield market in recent years. “In the current environment, we are focused on basic materials, energy and services as these are the areas where we see most potential for spread tightening.” It said.  

Barings has also made no major changes to its credit rating distribution. By this measure, it continues to focus on single B bonds and keep close to its 10 per cent limit in CCC as it believes lower rated bonds offer the greatest value in the current environment and are least correlated to rising US Treasury yields.

More generally, the firm added that it recognises that markets remain susceptible to external shocks – most notably in Europe – and cannot rule out a degree of volatility over the coming months. “However, we remain positive on the investment case given the low global yield environment and the robust fundamentals of high yield corporates and we will continue to view any periods of market weakness as potential buying opportunities,” Ugurtas concluded.

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