Years of quantitative easing have driven yields down on developed world government bonds and investment grade corporate bonds, making them unattractive to many investors. But high-yield bonds, as their name suggests, can offer more substantial returns. So are multi-asset managers using them?
Anthony Gillham, co-investment director of multi-asset at Old Mutual Global Investors, certainly is. ‘It’s an asset class we’ve allocated to for well over a decade,’ he said. ‘High-yield bonds give attractive risk-adjusted returns, and we’re currently overweight in our multi-asset portfolios.’
But Gillham, while enthusiastic, admits he is still picky. ‘We’re overweight US as opposed to European high yield,’ he said. Economic fundamentals underpin this positive US outlook: ‘These are solid, so we don’t think the country’s likely to go into recession. We’ll continue to buy from here.’
Short-dated bonds of between one and three years to maturity are currently favoured by the manager. He pointed out longer dated bonds give more yield, but have more volatility and are becoming less attractive. ‘When yields are high, it’s worth taking on the extra volatility,’ said Gillham. ‘But it’s not worth it when they’re low, as they are now.’
He also likes the lower volatility, relative to equities, often available with sub-investment grade bonds. ‘Most of their return is from their relatively high income,’ he said. ‘So the long-term performance of the asset class has a smoother return than equities.’
Sensitive to rate rises
Gillham, whose moderate risk portfolio currently holds around 8% in high-yield bonds, may be a lone voice in the wilderness. Eugene Philalithis, portfolio manager at Fidelity Multi Asset, said: ‘We’re neutral on high-yield bonds at the moment. This is after being positive for some time.’
Philalithis is concerned about the effect of monetary tightening from central banks across the world. ‘Today’s low yields mean the sensitivity of sub-investment grade bonds to interest rate rises is higher than it might have been historically.
‘This is because spreads, meaning the difference in yields between government bonds and high-yield bonds, are close to record lows,’ he said.
Meanwhile, Gillian Lakin, manager of multi-asset funds run by Brompton Asset Management, said: ‘Currently, we don’t have a very high allocation to high yield.’ And David Coombs, Citywire A-rated head of multi-asset investments at Rathbones, was more blunt: ‘We have almost no exposure to the asset class at the moment.’
High default risk
As with Philalithis, Lakin has concerns for high yield, ‘given the trajectory for US rate rises’. Due to its ‘reasonable correlation’ with equities, she considers high yield a ‘poor diversifier’.
She also points out the relatively high risk of default, compared with investment-grade bonds. ‘If rates do go up, there’s an increased potential for default,’ she said.
Even so, Lakin holds the Royal London Short Dated High Yield Bond fund. She thinks short-dated bonds have relatively attractive valuations. And, given their short time to maturity, there is high visibility regarding underlying issuers’ profitability and cashflows.
‘So there’s a good chance of receiving all coupons and capital repayments,’ she said. ‘Also, it can still benefit from that high-yield pricing anomaly.’
Coombs also highlights the relatively high correlation of high-yield bonds with equities. He brackets them as an ‘equity risk’ asset class. ‘If high-yield bonds looked better on a risk-return basis than equities, you’d reduce equities and add to high yield,’ he said. ‘But we wouldn’t reduce government bonds to do this.’
High-yield bonds do not currently ‘muscle their way in’ to his portfolios, Coombs added. ‘This is because their real, after-inflation returns are unattractive relative to equities, given the risk you’re taking. High-yield bonds used to be called junk bonds. It’s sometimes worth remembering that.’