High yield debt still favoured by UK fixed income managers

UK fixed income fund managers are positive about the continuing strong performance of high yield debt, says Standard & Poor's Fund Services in its latest sector update.

"With the exception of Stephen Snowdon at Old Mutual, all strategic and corporate bond managers interviewed felt sub-investment grade will carry on doing well over the next few months," says S&P fund analyst Markus Graf. Optimists noted that low absolute yields reflect low government yields not narrow credit spreads. They pointed to further tightening potential based on strong company fundamentals, falling default rates and continued demand from yield-hungry investors.

John Pattullo and Jenna Barnard, who run the S&P AA rated Henderson Strategic Bond Fund, held nearly half of the fund in this asset class at the end of January 2011 and expected this share to increase, particularly via global and US names. High yield also remained the strongest conviction for Richard Hodges at Legal & General, who held 40% net in early February in the S&P AA rated Legal & General Dynamic Bond Trust. Hodges is one of many managers who prefer sub-investment grade because of its lower sensitivity to interest rates should government bond yields continue their upward trend.

Some managers also felt that if M&A activity picks up, high yield will be the better place to be than higher-quality investment grade. Many high yield issuers are smaller companies that could benefit from a higher rating and/or debt buybacks by the acquirer, while the debt of highly rated investment grade debt is often negatively affected by such events.

Meanwhile, many managers have switched from bank into insurance debt, as they perceive better risk-adjusted returns in the latter, while bank issues are likely to be subject to further volatility, due to regulatory and sovereign debt uncertainty. Old Mutual Corporate Bond Fund, for example, has seen one of the biggest cuts in bank exposure over the past six months. In contrast to its high-beta profile prior to mid-2010, it is currently one of the more defensively positioned corporate bond funds.

An exception to this trend, however, is Invesco Perpetual, which believes that a combination of structural reform, deleveraging, conservative interpretations of Basel III and rising capital levels will be a powerful support for subordinated bank debt.