high-yield bonds can boost returns while reducing portfolio volatility, M&G's Simon Pilcher tells delegates at investment week conference
M&G has come out in agreement with Warren Buffet's strategy of shunning stocks in favour of junk bonds.
But to make strong gains, investors need to be able to sort the winners from the losers through in-depth credit analysis, according to Simon Pilcher, chief executive for fixed income at the group.
The asset class has performed strongly over the past nine months as investors have foreseen default rates peaking but high yield is also growing in popularity as investors see it as an important portfolio diversification tool, he said.
'Last year can be divided into two parts in terms of performance,' Pilcher told the Investment Week conference in Portugal earlier this month.
'The first two thirds of 2002 were pretty grim. Since then, there has been a fantastic environment for high-yield, returning around 20% over the past nine months. A key reason for the market performing is that people have understood the time to buy high-yield is when default levels are peaking.'
The other reason for recent popularity centres around the virtues of portfolio diversification, he continued.
'High-yield may be more risky in an absolute sense than investment-grade bonds and gilts,' said Pilcher. 'But because it is not strongly correlated with either equities or investment-grade bonds, adding high-yield into a portfolio means you can achieve the nirvana of higher returns and lower volatility.'
Many of the new high-yield issuers are former investment-grade companies that have defaulted, he said, naming Marconi, Ahold, Xerox and Alcatel.
Meanwhile, many individual companies are headed for the scrapheap, according to Pilcher.
An example of a high-yield company M&G is avoiding is steel manufacturer Corus. As well as overcapacity in the industry and poor management, there is significant liquidity risk, Pilcher argued. Property values may also be illusory because of the high clean-up costs associated with closing a plant.
Another theme in the market is that many private companies are now issuing debt. Examples include bakery company Kamps and WeightWatchers.
Of the 114 issuers now in Europe, 41 have no publicly quoted equity, according to Pilcher. While issuance by private companies opens up opportunities, it also means investment houses cannot rely on equity analysts to research these issues, he said.
Proper credit analysis is therefore vital, Pilcher added. Through good credit analysis, M&G was able to avoid most of the losers last year, he said.
There were 51 new issues last year, of which 22 went up, 28 went down and one had no change, leading to an average return of -9.8%.
Of the 20 issues bought by M&G last year, 15 went up, one had no change and four went down, the average return being 1.7%.
Among high-yield issues, Pilcher particularly favours Gala Bingo, which operates in a strong growth industry supported by government, and Yell, which has a dominant position in the UK and is growing by increasing its revenue per user.
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