Investors in high yield bonds have had a tough time recently, with sector benchmarks yielding close to record lows.
That has left the market looking expensive to many, with the Bank of America Merrill Lynch US High Yield index yielding just 5.5%, the lowest level since August 2014 and down from close to 10% seen at the start of last year.
In Europe, yields on junk-rated bonds are approaching record lows, leading Bank of America European credit analyst Ioannis Angelakis to call European equities ‘the new high yield’ due to the collapse in yields.
As a result, although the average amount of cash held by high yield bond funds generally has been 4-5%, some fund managers have been holding 9% or even almost 12% while they wait for more attractive opportunities.
Kames Capital’s High Yield Bond fund held some 11.7% of assets in cash earlier this year, which has since fallen to around 8%.
Phil Milburn(pictured), co-manager of the £1 billion fund, insisted he wants to get this down to around 5%, and said the ‘optically high’ cash position was about ‘liquidity management’.
He said the fund has a higher than normal cash position after selling some bonds in March: ‘When you have a high cash position, it can be a bit unrepresentative. It’s just about liquidity management. We’re slowly spending it.
‘We sold low beta positions with limited yield. We sell when the best bids are there and look to invest when there’s a bit of a wobble or good new issuance.’
Milburn added that May has tended to see a small wobble in bond markets, in line with the famous St Leger’s day adage, and that the fund has a higher cash position so it is ‘well placed to oppose any shorter term sell-off to create value over the longer term.’
While even 8% cash is an unusually high position, the Kames High Yield Bond fund is not the only one hoarding a bit of cash. Fidelity’s Global High Yield fund had 9.37% in the asset class at the end of April.
Amie Stow, investment director for the fund, said she has been reducing the portfolio’s exposure to the energy, senior financial, and basic industries sectors. She is now holding some profits after selling off bonds in the energy sector.
She said the fund is holding more cash than usual due mainly to valuations, with the market currently pricing in ‘virtually no defaults’.
She added that the lack of expected defaults could be because issuance has been ‘conservative’ while strong flows into high yield bonds as investors search for income have also ‘compressed’ valuations.
Stow said: ‘Fundamentally we don’t think that defaults are going to spike any time soon, there’s no systematic whole-sector defaults like the energy crisis.
‘We’re still seeing very good flows into the asset class, I don’t see that changing any time soon. High yield is the only area of fixed income where you can get a good income, I think.’
She added: ‘Most of what we are seeing is for refinancing, we’ve not seen any aggressive leveraging for buyouts or share buybacks.
‘Issuance is still fairly conservative, so at the moment we don’t see an environment where there will be a spike in the default rate.’
Agreeing that a normal cash position for high yield bond funds is currently around 4-5%, Axa’s global head of high yield James Gledhill commented: ‘If you went back pre Lehman’s, 2-3% would be viewed as an ordinary amount. Post Lehman’s, people would accept liquidity is now lower, so 4-5% is typically what people have.
‘My view is that we should have 4-5% and that’s simply because of the lower liquidity in the market.’
Cash has its place
Gledhill – who manages Axa’s Global High Income, European High Yield Bond, Pan European High Yield Bond, and Global High Yield Bond funds – believes cash has its place as part of a high yield strategy.
But he said to hold a high cash position ‘well’, investors need ‘some sort of trigger where you feel things will change’ and spreads will increase.
Gledhill added that unlike other funds he would be ‘uncomfortable’ holding more than between 6-7% cash.
He said: ‘We are being asked to run a fund in high yield bonds, it’s not our job to hold cash. People have instructed us to give them exposure to high yield bonds.
‘But clearly cash has its place, you can use cash to reduce duration for example, or you can use cash as a dry pound to put into the market when an opportunity avails itself.’