The outlook for UK and European high-yield corporate bonds is mildly positive for 2003, with stronge...
The outlook for UK and European high-yield corporate bonds is mildly positive for 2003, with stronger equities and economic growth expected to see lead to stability in credit ratings.
Some issuers, such as telecoms, are likely to remain out of favour but new issuance and improved earnings prospects in other parts of the market are tipped to give managers plenty to choose from.
David Fancourt, manager of the M&G High Yield Corporate Bond fund, believes equity markets are a key driver of high-yield bonds.
He says: 'They are like a halfway house between investment grade and equities. If equities have a good year in 2003, that should imply a positive year for high-yield as well because it means companies will have more financial flexibility and improved credit quality.
'The yields are still quite chunky so good returns could be seen even in a relatively benign economic outlook because you don't need much capital appreciation on top of the running yield.'
The slew of credit downgrades that eroded capital value among corporate bonds over 2002 is expected to slow and possibly reverse as issuers begin to renovate their balance sheets.
'We're expecting the default rate to fall,' says Fancourt. 'A lot of the tech, media and telecoms problems have now blown up and that should signal better returns as the risk premium on the asset class comes down.'
Fancourt adds he is still underweighting high-yield tech, media and telecoms names.
Managers will continue to watch the 'fallen angels' that have been downgraded from investment grade to high-yield or those that still have investment grade status but are trading on abnormally high yields in order to take advantage of mispricing and turnaround stories, he notes.
'Fallen angels seem to be making up a bigger portion of the index these days so are becoming more significant,' he adds.
After a dearth of new issuance in 2002, Fancourt believes managers are expecting the tap to be turned back on in 2003.
'There has been some new issuance recently and the banks seem to have a few deals up their sleeves,' he says. 'It should be good for diversification in the market because there won't be any tech, media and telecoms names coming out.'
Jupiter head of fixed interest John Hamilton feels the risks of high-yield bond investment are still quite high as the market is set to remain volatile.
'The average default rate on sub-investment grade bonds over a five-year period is quite significant,' Hamilton says. 'I'm not sure the risk/reward ratio in holding a portfolio of low-grade bonds, with the likely loss of capital, is better than holding investment grade bonds for which there is a much lower default probability.'
Despite the improvement in sentiment expected to accompany repairs to company credit profiles, Hamilton adds, the structure of high-yield issuers makes them dependent on a strong macro background.
'Credit ratings might be a bit more stable now,' he says. 'Companies are realising taking on enormous amounts of debt is problematic and they are trying to reduce that.
'But the high-yield market is made up of companies that take on a lot of debt and it is difficult to reduce debt unless they can grow earnings sufficiently.
Sentiment on sector expected to improve.
Credit downgrades expected to slow.
Yields attractive on corporate bonds.
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