High-yield bonds rallied last year, as yield spreads continued to narrow over government bonds. Although some managers of high-yield fixed-income mutual funds maintain the prospects for their funds are positive in 2011, they also caution that investors may have to temper their expectations.
\u201cWe\u2019re not going to experience the kind of returns we saw in 2009 and 2010 \u2014 really very good years,\u201d says Frank Gambino, vice president with Toronto-based RBC Global Asset Management Inc. <\/b>and lead manager of RBC Global Corporate Bond Fund and co-manager of RBC Global High Yield Bond Fund. \u201cGoing into 2011, we expect very modest capital gains. It will be a coupon-clipping type of year. Returns could be about 7%-9%.\u201d
Several factors favour this outlook. First, the market is supported by modest economic growth. Second, fundamentals, such as earnings and declining debt levels, are also improving. And third, Canadian high-yield bonds still offer yields of 6%-7% \u2014 almost double the yields of government bonds. Says Gambino: \u201cValuations seem very attractive relative to other fixed-income categories.\u201d
Moreover, positive sentiment regarding the asset class has attracted significant cash inflows. \u201cThere\u2019s been quite a bit of supply in the market,\u201d he adds, \u201cbut that\u2019s been met by strong demand.\u201d
Investors have bought in because high-yield bonds provide a measure of protection should interest rates start to rise again, Gambino explains: \u201cYou are starting with a bigger coupon stream, which could absorb capital losses from rising rates. But as the economy improves, the credit spread over government bonds should continue to contract.\u201d
Gambino says that the risk of a double-dip recession in the U.S. economy has dissipated. \u201cA lot of positive indicators have come out in the past few months,\u201d he says, noting that extension of the so-called \u201cBush tax cuts\u201d will act as a fiscal stimulus. And although the sovereign debt crisis in Europe is affecting market sentiment, he adds, on the whole, the asset class is weathering that crisis.
RBC Global High Yield Fund, co-managed by Jane Lesslie, vice president at London-based RBC Global Asset Management (U.K.) Ltd., has a split benchmark: 50% Citigroup high-yield index and 50% J.P. Morgan emerging markets bond index. Currently, 44% of the fund\u2019s assets under management is in emerging markets, 54% is in North American high-yield bonds and 2% is in cash. There are about 190 holdings, including bonds issued by Turkey, Indonesia and U.S. firms such as Ford Motor Credit Co.
RBC Global Corporate Bond Fund is benchmarked against six indices (dominated by the Barclays U.S. corporate bond C$ index). About 70% of the fund\u2019s AUM is in U.S. and Canadian investment-grade bonds, 15% is in U.S. high-yield bonds, 10% is in emerging markets and 5% is in cash. The fund holds more than 450 securities, with larger holdings by issuers such as JPMorgan Chase & Co. On average the bonds are rated BBB- or better. Says Gambino: \u201cWe are using emerging markets and high-yield bonds to enhance the return potential of a fairly high-quality global corporate bond portfolio.
Although Investors Have<\/b> reaped the rewards in the past year, buoyant market conditions have encouraged the issuance of many new bonds that require careful scrutiny, says Jean-Pierre D\u2019Agnillo, vice president at Montreal-based Standard Life Investments Inc. <\/b>and manager of Standard Life Corporate High Yield Bond Fund. \u201cIt has been a record year,\u201d he says, noting that there were about $3.5 billion in new issues in Canada and US$261 billion in the U.S. in the 11 months ended Nov. 30, 2010.
\u201cIt has been one of the strongest years in Canada,\u201d he says. \u201cIn the pursuit of higher-yielding assets, investors have embraced this type of product. Before 2009, there were a handful of Canadian issuers, which included companies [such as] Shaw Communications Inc. and Rogers Communications Inc. Now, they\u2019ve been bumped up to investment-grade. Since then, more than a dozen new issuers have come to market in Canada.\u201d
But D\u2019Agnillo is concerned about the pricing of the new issues \u201cThe theme is the same: a lot of buyers and prices rallying on the break,\u201d he says, referring to the way these bonds had rallied soon after being issued. \u201cThere has been a lot of demand. This has supported the market.\u201d@page_break@Yet, investor interest has begun to wane slightly since Government of Canada bond yields started to climb in October (10-year bond yields have since moved to 3.17% from 2.75%). Says D\u2019Agnillo: \u201cCorporate bonds have the benefit of more yield, so that cushions the blow of principal loss if spreads rise.\u201d
Currently, the benchmark DEX high yield index is yielding about 6.97%, which means there is a 460-basis-points spread over five-year Canadas.
D\u2019Agnillo manages a portfolio in which the average credit rating must be BBB, which is higher than most competing funds. The Standard Life fund can hold some high-yield bonds, but he admits to being very picky. Currently, 60% of the fund\u2019s AUM is in A-rated bonds or higher, 39% is in BBB and only 1% is in BB or lower.
\u201cEvery week, we see a new issue and do our homework,\u201d says D\u2019Agnillo. \u201cIt has to fit our expectation of pricing.\u201d He has not bought some high-yield issues because of the nature of their businesses; others did not meet his pricing expectations. \u201cWe do the same thing for investment-grade bonds,\u201d he adds.\u201dIt\u2019s a twofold decision: if we like the credit, that\u2019s one side, but if it\u2019s too expensive vs comparables, we just won\u2019t buy it.\u201d
The Standard Life fund\u2019s high-yield exposure has shrunk in the past year, largely because many bonds in the portfolio were upgraded in 2009. Meanwhile, D\u2019Agnillo has been buying issues by firms such as Rogers, whose bonds are now investment-grade. From a sectoral standpoint, 24.6% of the Standard Life fund\u2019s AUM is in banks, 18% is in media and telecommunications, and there are smaller holdings in areas such as energy, resources and infrastructure.
Running a 46-name fund, D\u2019Agnillo added one issue early last year: Montreal-based cable operator Vid\u00e9otron Ltd., which issued a 10-year, BB-rated bond that now yields 6.25%. Says D\u2019Agnillo: \u201cWe liked the business. It\u2019s very well run. And it was issued in a period in which the market was taking off in Canada, so the pricing was more interesting than what is available now.\u201d
The High-Yield Bond Asset<\/b> class is between slightly cheap and fair value, says Terry Carr, vice president and managing director, fixed-income, with Toronto-based MFC Global Investment Management<\/b> (Canada<\/b>) and lead manager of Manulife Corporate Bond Fund. \u201cBut it still represents \u2014 given the opportunity of other asset classes, such as government bonds, investment-grade corporate bonds and equities \u2014 reasonable valuation and protection features with moderate upside potential on a spread basis.\u201d
Carr, who shares management duties with MFC vice president Richard Kos, argues that the U.S. benchmark Bank of America Merrill Lynch high-yield master II index spread is about 600 bps over U.S. treasuries, or slightly above long-term averages of 550 bps. \u201cWith about 100 bps above long-term averages, and notwithstanding a weak economy, default rates are very low and trending lower. Something that yields about 7.8% (the U.S. benchmark yield) will have a strong place in a portfolio,\u201d says Carr, who expects high-yield funds could return 5%-10% in 2011. \u201cIf things continue to improve from here, high-yield bonds will dramatically outperform government securities.\u201d
Carr believes the economy is making slow progress while enduring bouts of pessimism and optimism. \u201cGovernments and central banks are doing the right thing,\u201d says Carr, \u201cand over time will win the battle. So, from an asset class allocation, you want to place your bets on things on the riskier side as opposed to the safest bets, government bonds. We adhere to this theme going forward, but do it in moderation.\u201d
From a strategic viewpoint, about 56% of the Manulife fund\u2019s AUM is in high-yield bonds (of which 40% is in U.S. securities that are protected by a currency hedge) and 44% is in investment-grade bonds that are mainly Canadian. The maximum allowed is 66% in either asset class. Says Carr: \u201cAre we erring on the side of extreme caution, or modest risk? We\u2019re taking a modest risk and are slightly overweight [in] high-yield.\u201d
During the winter rally, the Manulife fund sold some lower-rated bonds and took profits, says Carr: \u201cWe\u2019re taking things that were way overpriced out of our high-yield mix, but are trying to find other good opportunities to invest in.\u201d
Running a portfolio of about 100 high-yield names and 100 investment-grade firms, last autumn the Manulife fund acquired an unrated bond of customs broker Livingston International Inc. yielding about 8.7%. Says Kos: \u201cWe [saw] a tested business model and there\u2019s a lot of opportunity for growth.\u201d\tIE<\/b><\/p>\n","protected":false},"excerpt":{"rendered":"
But managers of high-yield fixed-income funds suggest that investors be cautious in 2011<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[3013,3017],"tags":[2341,2407,2668],"yst_prominent_words":[],"acf":[],"_links":{"self":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/316751"}],"collection":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/comments?post=316751"}],"version-history":[{"count":1,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/316751\/revisions"}],"predecessor-version":[{"id":368654,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/posts\/316751\/revisions\/368654"}],"wp:attachment":[{"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/media?parent=316751"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/categories?post=316751"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/tags?post=316751"},{"taxonomy":"yst_prominent_words","embeddable":true,"href":"https:\/\/www.investmentexecutive.com\/wp-json\/wp\/v2\/yst_prominent_words?post=316751"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}