A strong weighting in high yield has lifted the AA-rated DWS Corporate Bond Plus fund into the top 1...
A strong weighting in high yield has lifted the AA-rated DWS Corporate Bond Plus fund into the top 10 in its sector over three months.
The portfolio's 4.5% return over the three months to 2 June ranks it number 10 out of 80 funds in the UK Corporate Bond sector, which on average posted growth of 3.2% before charges.
Manager Charles McKenzie remains bullish on the asset class, maintaining a 19% weighting in global sub-investment grade debt, hedging returns back into sterling to avoid currency risk.
'There has been a significant rally in high yield bonds,' McKenzie said. 'The asset class has been strong since last summer and high-yield spreads have contracted from 10% to 6.5%-7% above gilts, which has been positive for the fund.'
Although bullish on the asset class as a whole, McKenzie has diversified his exposure to high yield across 165 holdings to mitigate the risk of defaults. This means a little over 68% of the fund's holdings by number make up just 19% of its exposure in asset terms.
'We are still seeing real value in high yield but because of our concerns over the level of economic activity, we are concerned about defaults and have diversified away as much of this risk as we can,' McKenzie added.
Although equity markets have rallied significantly since March, McKenzie is sceptical about the imminence of a sustained global bull run. He believes a low growth, low inflation environment, typically positive for corporate bonds, will persist for the foreseeable future.
Investor nervousness and record default levels were the main causes of high yield becoming so oversold, McKenzie said. Against the current economic backdrop, while low interest rates are positive for the many indebted companies in the high-yield universe, low inflation and low economic growth clearly mitigate this benefit to an extent, prompting McKenzie's caution.
This cautious optimism is also manifested in the fund's 31.9% weighting in AAA-rated paper spread across 21 holdings, including 4% exposure to European government debt.
'Within AAA bonds, there are still pockets of value but these are largely skewed towards asset-backed issuance,' McKenzie noted. 'A lot of supranationals have also performed well of late, though.'
His two largest holdings are both asset-backed AAA-rated bonds, each yielding well above the swap rate. Chester Asset Receivable 2005, which draws income off a portfolio comprised of MBNA's credit card book, is yielding 6.625% and makes up 2.43% of the fund's holdings.
McKenzie's largest position, an asset-backed Canary Wharf issue, comprises 2.77% of the fund's assets. The bond is undervalued after a major decline in the group's share price adversely affected investor confidence in the issuance, he said.
Whereas AAA-rated paper would normally trade on a spread 18 basis points over Libor, Canary Wharf is on a current spread of 72 basis points over Libor.
DWS's bottom-up investment process is geared to picking up such a mispricing, he said.
The group's buy and sell discipline is borne out of a focus on credit and bond structure analysis. The credit assessment attributes a fair credit premium for the risk associated with the issuer, sector and swap spread. This, coupled with compensation for any liquidity and structural concerns, provides DWS with a fair value target price expressed as a percentage yield above government bond rates.
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