Kames bond veteran Philip Milburn has warned that some firms are ‘abusing the bond market’ in order to gain access to bank-like funding.
He believes this development has led to a significant deterioration in the structure of corporate high yield bonds, particularly in Europe.
Milburn, who runs the Kames High Yield and Strategic Global Bond funds, said, while defaults are likely to remain low and leverage levels are below their 2009 peak, many companies are raising debt of questionable quality to leverage up their equity returns.
Speaking to fund selectors at the firm’s Edinburgh headquarters, Milburn said: ‘US monetary policy will be the biggest factor in changing the investment cycle and there will be a little wobble in high yield on the first rate rise before the market rights itself, but it is hard to see a big rise in defaults.'
‘There may be a load of Italian gaming companies and firms like Xerox last year issuing poor quality bonds but the deterioration in the bond structure is the biggest problem.'
'Reading the small print is crucial and I don’t like the continuing asymmetry of return profile, especially in Europe.’
Milburn added that ‘more and more companies were issuing debt structures with at best questionable, and at worst down right insulting’ debt structures. He said ‘anyone that thought they could get away with it’ was doing so.
‘If bond holders are not careful, they could be stuck with poor quality paper, often for up to seven years.’
Milburn said the problem was caused by a proliferation of new issues in primarily European high yield, from companies which had not yet gone through a full business cycle. He said the number of issues had quadrupled in the past three to four years.
With that in mind, Milburn said he was maintaining a defensive backbone for the fund and is favouring US high yield over European.
‘We are favouring US high yield mainly because treasury yields are a bit better, as well as being a bit longer duration and having wider spreads.’
While long term performance remains strong, Milburn admitted that he had ‘dialled down the risk’ on the high yield bond fund too early, which had led to the fund being 30 basis points behind its benchmark over one year.
‘We had too much in high yield too early. This year we expect European and US high yield to return about the same so want a lower beta strategy.
The €2 billion fund currently has 60% in US dollars, 15% in euros and a further 20% in sterling. ‘If there is a rush to the exit at some point, the UK market is not as big or liquid as the other two,’ he said.