Donald Phillips

10 things everyone should know about high yield bonds

Donald Phillips

The high yield bond market is not only currently being ignored by most professional and retail investors, but it has also been the subject of several negative articles recently. We disagree with some of the analysis and rather believe there are a number of reasons why investors should in fact include high yield bonds as part of their portfolios. In this article, we provide 10 key points to remember about high yield (as well as our own GF High Yield Bond Fund).

1). The resilience and strength shown by the high yield bond market over the past 12 months is not unique: high yield consistently performs well relative to equities.

 

high yield bonds versus equities


Source: Bloomberg, to 22.11.19. Columns are total return and red dash lines are maximum drawdowns

2). High yield’s resilience as an asset class comes from its income-generating characteristics. The global market is $2 trillion in size and produces $10 billion of coupon on average every month. Over the past five years, the global high yield market has produced a return of more than 25%. Considering this total return has included a negative price return (-1%), the income generated by the companies in the market has provided 118% of the total return. Moreover, as we can see in this chart, income-providing resilience is typical of this market over the long term.

 

coupons are king


Source: Bloomberg, 01.02.98 to 28.02.19

3). In a world of low yields, high yield bonds offer investors a potential return comfortably in excess of inflation. Other fixed income assets do not.

 

comparing bond yields


Source: Bloomberg, as at 22.11.19

4). Is the high yield bond market junk as its reputation suggests? Like any market, there are good options and bad options, winners and losers, and this means investors should be selective. We place a huge importance on competitive advantage, transparency and the motivations of owners and managers, leading us to prefer stock market-listed businesses. Listed companies are a high proportion of our Liontrust GF High Yield Bond Fund and they tend to be large companies.

 

no junk here

5). Many investors think the global high yield bond market is full of US energy market risk. Given US energy accounts for 12.5% of the US market and close to 7.5% of the global market, this is a reasonable perception. The Liontrust GF High Yield Bond Fund, however, is index agnostic and seeks to avoid accumulations of thematic risk. We currently have 0% exposure to US energy, 0% to base chemicals and 1% to mining. Commodity cyclicals can rise and fall on one theme (such as the oil price), and therefore it can be dangerous to be ‘neutral’ versus the index weighting and believe that you are not taking risk. We prefer non-cyclical and idiosyncratic exposures, which present the best opportunity to identify bargains rather than crystallising losses in trickier market environments.

 

portfolio construction - avoiding the thematic risk


Source: Liontrust, UBS Delta excluding cash, 31.10.19. The index is the ICE BAML Global High Yield. Size of bubble = size of over/underweight, green is overweight, beige underweight

6). Investing in fixed income usually comes with some degree of interest rate risk. During the period of quantitative easing (QE), interest rates have been kept low, creating a tailwind for any asset with a yield. In a world with less QE, there are negative implications for the direction of interest rates. If rates in general increase, fixed income assets, to varying degrees, lose their value.

The extent to which they lose value is measured by duration. A duration of five means, other things being equal, a bond will lose 5% of value for every 1% increase in rates. High yield is among the less interest rate sensitive parts of the fixed income landscape.

 

lower duration on high yield


Source: Bloomberg, as at 22.11.19

7). We believe high yield is an asset class for which active management offers advantages over passive investment. ETFs do a bad job at tracking recognised high yield indices primarily due to trading costs, and they also contain the accumulations of thematic risk that come with indices. A good active manager should be able to materially outperform a global high yield ETF over the long-term after fees. When presenting the performance of the Fund, we compare it against the ICE BofAML Global High Yield Index. The chart below shows our performance since launch.

 

performance of fund (GBP) since launch versus index and sector


Source: Financial Express as at 29.11.19, Liontrust GF High Yield Bond Fund C5 Acc in GBP, income reinvested versus comparator benchmarks ICE BofAML Global High Yield Index hedged in GBP and IA Sterling High Yield in GBP, since inception (08.06.18)

 

performance of fund (EUR) since launch versus index


Source: Financial Express as at 29.11.19, Liontrust GF High Yield Bond Fund A5 Acc in EUR, income reinvested versus comparator benchmark ICE BofAML Global High Yield Index hedged in EUR, since inception (08.06.18)

 

8). To avoid many of the pitfalls of a passive or index-relative approach to high yield markets, we believe in having a concentrated portfolio, as well as investing for the long term. The Liontrust GF High Yield Bond Fund has 83 bonds (less than 70 issuers), a fraction of high yield bond ETFs.

 

a focused portfolio number of holdings


Source: Liontrust, as at 22.11.19

9). Good ESG (environmental, social and governance) credentials in high yield is not solely the domain of specialist managers. We seek transparent businesses with good management and owners. We also want to avoid accumulations of thematic and cyclical risk, regardless of what an index might be telling us to do. The Liontrust GF High Yield Bond Fund has a BBB ESG rating from MSCI, superior to the ICE BAML Global High Yield Index’s BB.


10). Experience matters. The Global Fixed team who manage the Liontrust GF High Yield Bond Fund has a combined 28 years of experience of investing in this asset class and excellent long-term track records.

 

experienced managers


Source: Citywire Discovery, data from 30.11.07 to 31.07.17. Performance in USD based on all funds registered for sale in the global peer group the manager has run in the sector during the period. Total returns calculated gross of tax, ignoring the effect of initial charges and with income reinvested at the ex-dividend date

 

experienced managers phillips


Source: Citywire Discovery, data from 31.05.10 to 31.12.17. Performance in GBP based on all funds the manager has run in the sector during the period. Total returns calculated gross of tax, ignoring the effect of initial charges and with income reinvested at the ex-dividend date

 

Discrete 12 month performance to last quarter end (%)*:

 

 

Sep-19

Liontrust GF High Yield Bond A5 Acc (in euros)

5.3

ICE BofAML Global High Yield Hedge EUR

4.3

Liontrust GF High Yield Bond C5 Acc (in sterling)

6.6

ICE BofAML Global High Yield Hedge GBP

5.4

IA Sterling High Yield

4.7

 

Discrete data is not available for five full 12-month periods due to the launch date of the portfolio.

Source:
Financial Express, total return, net of fees and interest reinvested.

 

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.


Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, December 9, 2019, 10:51 AM