Investors should "snap up" high-yield bonds

Western Asset claims that concerns over global growth, central banks starting to tighten policy and a lack of liquidity have all contributed to a "painful re-pricing" of high yield in the last three months.

As investors fled to US treasuries and other government bonds, the manager says that US high-yield spreads over US treasuries jumped from around 3.4% in June to as much as 5% in September.

Michael Buchanan, head of global credit at Western Asset, believes that this has left high yield as "one of the most attractive areas within fixed income that investors can access".

Income Advantages

"With the overall interest rate environment at very low levels, yields of 6% or more on some high-yield bonds have been capturing investors' attention. To us, the spreads are now very attractive and high yield can offer strong income advantages over other fixed-income asset classes," argues Buchanan.

In addition, Buchanan argues that with the Fed unlikely to raise interest rates anytime soon, monetary policy remains "accommodative" for fixed income; additionally, default rates remain low, and the recent sell-off has removed fears over a "bubble" in the asset class.

John Pattullo, head of retail fixed income at Henderson Global Investors, largely agrees with Buchanan's analysis but says he would avoid companies with poor credit ratings.

"We think high yield is reasonably attractive; however, we are wary of small companies with lower credit ratings. We do not expect any top-line growth from European high-yield businesses, so we do not want to lend to over-geared, cyclical or small businesses, as they tend to have higher default rates," he says.

However, David Thornton, senior investment manager at Premier Asset Management, believes high yield may still face a liquidity problem in the future.

Note of Caution

"Broadly speaking we believe this might be a good time to be adding to high-yield exposure, but as always it is not as simple as it looks. Excess spread easily compensates for the current default rate, but part of that excess is compensation for the potential illiquidity of high-yield bonds.

"The high yield market has plenty of liquidity when investors are scrambling to get in and corporates are keen to issue debt at cheap levels, but it can be quite a different story when investors are all looking to the exit door at the same time if interest rates rise," he says.

Year to date, the Investment Management Association sterling high-yield bond sector has underperformed all other fixed-income asset classes, returning 2.5% compared to 7.5% from the sterling corporate bond sector and 13% from UK index-linked gilts.

Overall, Bryn Jones, manager of the Rathbone Strategic Bond fund, advises caution on the sector. "Default rates on high-yield bonds had declined compared to long-term averages, but the recent moves have taken them back to average," he says.

"This suggests they have gone from overbought to fairer value. However, what is priced in is not screaming cheap, just decent value if you think the default rate will remain benign.

"Investors should also note the US high-yield market has a large weighting to energy bonds. With declines in both the oil and energy prices, there may be margin pressure in a large component of the high yield basket, so caution and skill is advised."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.