As fixed income investors turn to high yield amid talk of the end of the bond bull run, Ken Rayner, director at Rayner Spencer Mills, urges caution...
Sterling high yield bond funds are defined as those which invest at least 80% of their assets in sterling denominated (or hedged back to sterling) fixed interest securities, and at least 50% in below BBB-minus fixed interest securities (as measured by Standard and Poors or an equivalent external rating agency), including convertibles, preference shares and permanent interest bearing shares.
The ability for bond investors to make significant gains over the coming years has been questioned recently and yet we have continued to see support for a wide range of assets through 2012.
The main reason for this continued strength has been the support of the central banks through quantitative easing and a deliberately loose monetary policy that has kept demand for government debt strong and interest rates low.
Is high yield worth the risk?
Many investors have been risk averse, looking to hold less risky assets as the core to their portfolios and there has been a demand from institutions and pension funds to maintain their liability-matching requirements, keeping demand high for regular coupon investments. In recent months we have seen some of the demand reduce as greater risk taking by investors and those seeking higher yields has seen yields rise a little. However, there has been no definite rotation as yet.
Many bond investors feel this situation is about to change and that the only real opportunities will be in high yield debt, where there is still some room for the spreads to other assets, such as investment grade bonds, to reduce, providing some capital uplift.
High yield investments are, however, higher risk and more equity-like in response to changes in sentiment than other types of fixed interest, meaning they are not appropriate for everyone. The likely risks in high yield investments are also measured in the potential default rate of these assets measured by the market. At the moment, this is still relatively low but if interest rates were to rise then expectation of defaults would also rise, creating pressure on the high yield market.
Finding the balance
At a company level, companies with strong cash flows have generally been reducing their debt burdens, which is a positive, subject to the right level of investment also taking place to stimulate growth.
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