High yield corporate bonds expected to continue to do well, asset managers believe

Written by Ray Clancy

Tuesday, 26 October 2010 10:42

In contrast to their emerging market peers, most advanced economies are facing a prolonged period of sluggish growth and little inflationary pressure but it is not all bad news for investors, it is claimed.

Indeed, asset classes such as high yield corporate bonds should continue to excel in such an environment, according to asset managers.

The latest outlook report from the Julius Baer Global High Yield Bond Fund, managed by Swiss & Global Asset Management, says that valuations are compelling.

‘Unlike equities or commodities, credit investments are not a leveraged play on economic expansion. They do not necessarily need strong growth to deliver their full potential,’ it says.

‘Empirical evidence suggests that we could see attractive returns from high yield bonds in a low-for-longer growth environment. Returns from high yield bonds have historically been highest (16.5% per annum on average) during periods of 0% to 2.5% GDP growth, compared to single digit returns during times of faster economic expansion,’ it adds.

It also points out that valuations are also compelling. ‘Current credit spreads of 600 basis points are twice as high as during past economic recoveries and significantly overcompensate for potential net losses from issuer defaults. Default rates are expected to fall from the current level of 4% to just 2% over the next 12 months, and this compares to default rates of close to 13% only a year ago. In addition, credit ratings of high yield companies are being upgraded at a ratio of 2:1, the highest level since the mid-1990s.’

Looking ahead it expects high yield corporate bonds to continue to produce double digit annual returns as a result of tightening credit spreads, reasonably stable benchmark yields and low default rates. ‘Buying of high yield bonds over the past 18 months has mainly come from non-leveraged, long-only strategic investors, which combined with reduced refinancing needs and bond issuance by companies, should provide a very solid technical market backdrop,’ the report says.

The fund invests in corporate high yield bonds globally, including emerging market issuers, and follows an active, bottom-up approach. The management team, which has been in place since the fund’s launch in December 2002, currently favours single B-rated issues over double-B or CCC-rated credits and US as well as emerging market corporates over European names.