If a 21st-century Martin Luther were to nail a list of heretical theses to a church door, one could be that high yield bonds are a defensive allocation. 2018 is suggesting that that may, however, be the case. Through the first five months of the year, the Markit iBoxx USD Liquid High Yield index remained virtually flat, even as Treasurys and investment grade bonds weakened by 1.5% and 4% respectively.
Oleg Melentyev, credit strategist at Bank of America Merrill Lynch, nevertheless recommends a tactical underweight to high yield at the moment, with a longer-term strategic spread target of 380 basis points that is around 35 basis points above prevailing spreads.
'High yield market remains vulnerable over the near-term horizon to risk re-pricing in emerging markets and the European Union,’ he explained. ‘What offset some of this sentiment-driven overhang are the high yield technicals, which remain very strong.
‘It is our sense that extreme risk-sentiment changes could still overwhelm slow-moving technicals over short-term time horizons, although the latter should be taken into account in determining the appropriate portfolio beta here,’ Melentyev advised.
LARGEST BY AUM
Vanguard once again claims the largest fund in a category, and once again it has done so through an active strategy. In the case of the Vanguard High Yield Corporate fund, the manager is Michael Hong of Vanguard’s longstanding collaborator Wellington Management.
Despite being an active fund, the fund charges less (just 0.13% for its Admiral shares) than the most popular ETFs in the category, HYG (0.49%) from iShares and JNK (0.4%) from State Street.
Wellington noted that passive options struggled to replicate the massive high-yield universe effectively and also could not exploit the structural inefficiencies in that market.
TOP BY RISK-ADJUSTED
Citywire AAA-rated manager Bryan Krug boasts the top total returns in the category and the best risk-adjusted returns over the past three years, with a personal information ratio of 0.99.
Krug has remained sanguine in the face of the turbulence witnessed so far in 2018.
‘Despite the recent increase in market volatility, it’s important to remember that credit fundamentals are no different than they were a few months ago,’ he insisted, adding that it may create buying opportunities. ‘As market expectations shift from overly optimistic to overly pessimistic, short-lived bouts of volatility can create opportunities for diligent credit pickers.’
ONE TO WATCH
The Prudential Short Duration High Yield Income fund – managed by Robert Cignarella, Terence Wheat, Robert Spano, Ryan Kelly, Brian Clapp and Daniel Thorogood – has surged up the performance table to 29th out of the 166 funds in this sector over the past year, having been in 115th place over the previous 12 months.
Part of this is inevitably attributable to the fund’s short-duration mandate: the Markit iBoxx USD Liquid High Yield 0-5 index has returned 3.6% over the past year, compared with 2.4% from the broader Markit iBoxx USD Liquid High Yield index. But the team was also boosted by security selection in the technology, healthcare and midstream energy sectors.
Invesco Fundamental High Yield Corporate Bond ETF
Passive funds have tended not to thrive in high yield bonds. Alternative indexation methodologies can nevertheless help them mitigate the risks of blindly holding debt based only on the size of a company’s issuance.
The Invesco Fundamental High Yield Corporate Bond ETF, for example, is based on a Research Affiliates index. This uses fundamental measures of issuer size, including book value, sales, dividends and cash flow to set constituent weights.
This has left its portfolio higher in quality than market-cap weighted indices. Its emphasis on bonds with a maturity of up to 10 years also makes it shorter in duration than whole-of-market approaches.