By Kira Nickerson Scottish Widows' frA rated High Income bond fund is looking to increase its weigh...
By Kira Nickerson
Scottish Widows' frA rated High Income bond fund is looking to increase its weighting in sub investment grade US bonds despite negative sentiment and a rising default rate.
The fund, which has £220m in retail assets and launched little more than a year ago, currently holds some 68% in high yield bonds but the managers are looking to increase this to between 70 and 77% in the New Year.
While the high yield sector in the US market has looked unattractive as of late due to an increase in the number of defaults, the managers of the fund, US bond specialists MacKay Shields, believes it is now looking good value.
Matthew Philo, joint manager of High Income which is run from New York and offers a redemption yield of 9.54%pa, said: "The high yield market has been weak and with good reason. Defaults have risen to around 5.13%, which is uncomfortably high and according to Moody's bonds are three times as likely to undergo downgrades as opposed to upgrades. Liquidity in the market is also high."
Joseph Portera, joint manager of the fund, said: "We like the market at the moment because it is cheaply valued. It has not been this cheap since the early 90s."
While the default rate across the market is high, the rate on the portfolio is around 1%.
The fund is structured so it is somewhat protected from any holding defaulting. There are around 120 holdings and only a few stocks would make up as high as a 3% weighting in the portfolio, Philo said. Diversification is also achieved through sectors, with the limitation of not going more than double the index weighting of any particular sector.
While it is rare for the fund to double the index weighting in any sector and most are held at around 5%, Philo said this flexibility allows the group to hold a lot in telecoms if they believed the sector was good value. They are underweight telecom, cyclicals, automotives, steel and retail and favour cable television, electrical utilities and healthcare with the high yield area.
Philo said: "Cable TV companies and telecoms are chasing the same markets but their systems are already in built. They are also much closer to positive cash flows than telecom companies, which need ongoing money just to survive."
Positive cash flows are an important aspect when choosing holdings in the fund, as is asset coverage. The group tries to focus on those companies whose asset value is two times the level of the debt issuance.
The portfolio is currently split 68% in the high yield area of the market with the US portion hedged back into sterling, 32% in gilts and around 6% in investment grade denominated in sterling. Typically the split in sub investment grades is 30% in BBB or BB, 35% in BB or B, 30% in B/ CCC and 5% in restructuring opportunities, according to Standard & Poor's Fund Research.
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