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Analysts dispute high-yield bubble talk
By Elsa Buchanan | Wed, 3rd April 2013 - 17:38
Widely held by investors worldwide, usually through mutual funds or exchange-traded funds, high-yield bonds have been selling like hot cakes as investors turn to riskier investments.
However, recent widespread media coverage of an investment strategy note addressed to clients of Coutts that warned of a potential "collapse of the high-yield debt market" has had investors and wealth managers worrying about whether they should reduce exposure to the sector.
But a source close to the matter told Interactive Investor that the media had neglected to mention the "warning" - allegedly issued earlier this month - was directed at Asian wealth managers and investors, not UK investors.
"It's really an Asian story," comments the source. "Looking at high yields, the warning is really for Asia investors where [analysts] see the over-leverage and that Asian investors are buying lots of fixed income; not UK investors."
Coutts also denies having warned its clients of a global collapse of the market with Alan Higgins, chief investment officer, UK at the investment bank, saying: "We continue to hold high-yield debt in portfolios and don't anticipate a sell-off in these markets in general."
Ollivier Courcier, fixed income head and strategist at Société Générale Private Banking, shares the Asian theory. He explains: "One very true point is that Asia has the most expensive credit universe within the emerging markets, compared to Latin America, or Eastern Europe and the Middle East, so Asia is more expensive in terms of spreads."
Indeed, Asian companies with below investment-grade credit ratings sold over $9.1 billion (£6 billion) high-yield bonds in 2012, representing a year-on-year increase of more than 6,000%, according to statistics compiled by data provider Dealogic.
This dramatic increase means Asia consumed 17% of the global high-yield bond market for the period; the biggest ever share of market recorded by the region.
Why are banks worried about Asia's high-yield debt market?
There has been an increase in risks taken in Asia, with investors borrowing more to enhance returns.
Courcier explains the risk lies in the fact that Asian investors are "going to borrow short term, given the low-yield environment of the short term and invest in longer maturities."
He explains using borrowed money in a "hunt for return" is prevalent in Asia. "The result could be a kind of asset liability management risk where you would see short-term borrowing costs rising, and borrowers not being able to repay because of the cost of financing rising," he adds.
Thus, says Courcier, when certain banks say they should be reducing their position on Asia, those warnings "make sense". "If you have a look across the different emerging markets at the moment, it is the market [Société Générale Private Banking] are a little bit more cautious about.
"It doesn't mean that we think we shouldn't be investing, it just means that in terms of deterioration of the capital, Asia is riskier than Latin America or [Europe, Middle East and Africa]," he concludes.
Higgins from Coutts concludes the only warning the private bank is giving to investors is: "Don't borrow to invest in high-yield bonds."
Is the high-yield market in a bubble or not?
Like most other fixed-interest markets post-crisis, quantitative easing (QE) pushed up high-yield debt market valuations, resulting in an expensive market.
"You can call it a bubble," says Mouhammed Choukeir, chief investment officer at Kleinwort Benson, adding a variety of signs can indicate when the asset class is overbought, but timing the bursting of the bubble is "impossible".
Higgins and Courcier dispute the existence of a bubble, explaining it would not be the result of a rise in high-yield prices, but of "a sudden increase in the borrowing cost for investors".
Yet, Courcier says: "We are still in a global context where you have massive liquidity within the system because lots of issues are having to be addressed in many places in the world with very active QE policies: the US is over-leveraged, as is the UK or Europe."
Should I steer away from high-yield bonds?
Compared to a historical basis, Courcier points out, default rates are increasing by 10, 20 or 30 basis points (bps), "but they are still 100 bps below the historical average, whichever market you are looking at".
"I think it's very much under control and if you stick to investing in short-dated bonds in two, three or four years maturity and draw your own credit analysis, it still makes a lot of sense to be investing in high-yield bonds, globally speaking."
He adds investors looking at high-yield bonds in developed markets will still probably see a 5.5% or 6.5% annual return, which he says is "not too bad" for durations of three to four years.
Kleinwort Benson's Choukeir highlights that high-yield valuations are becoming "less compelling", but admits being "far more constructive on cash-generative investment grade corporate debt... [which] still offers better value than government bonds and helps reduce volatility in multi-asset portfolios".
A spokesperson at Coutts explains: "In terms of high-yields, we are not saying that clients should pull out. We are maintaining positions, and are certainly not selling all high-yields."
That said, Higgins adds: "We are cautious on certain high-yield sectors, including Asian high yield which is dominated by commercial property in China and the region's more recent 'CoCos', which are highly subordinated bank debt. Where our portfolios do hold high-yield debt, this is typically limited to 2-4%, depending on client risk profiles, and primarily in the healthier US high-yield market."
He explains: "We continue to see so-called 'safe-haven' government bonds, namely US Treasuries, German bunds and UK gilts, as more at risk than corporate bonds to further rises in yields. Though better than government bonds, we see the scope for positive returns from investment-grade corporate bonds as being modest at best."
Courcier concludes by advising investors to be "more cautious" on investment grade-bonds and credit bonds "because they are very expensive and they don't protect against inflation", and be very negative on sovereign bond markets "which are very expensive and could potentially pose a big risk".