Where’s the value?
Recent data from our sister publication Asset Allocator indicates that, over the course of 2022, allocators have moved away from strategic bond funds and towards mandates investing in emerging market debt and high-yield bonds.
Brady says he is investing “selectively” in both of those areas but he is conscious that those areas are economically sensitive, and as he is cautious around the economic outlook, he notes “we are investing only in the assets with the lowest credit risk”.
Kris Atkinson, fixed income investor at Fidelity, is also wary of taking on extra credit risk. He says he does not believe high-yield bonds are presently priced to reflect the potential impact of a recession.
He says the quality of the high-yield bond market should be viewed through the prism of the impact of quantitative easing on the market.
Atkinson says the central bank bond-buying programmes made bond market funding easy to obtain for even low-quality companies.
He says this means there are far too many low-quality companies in the high-yield market right now as a result of this, and he feels higher interest rates mean credit conditions have tightened, with the result that many high-yield borrowers will go bust in the coming months, and means the aggregate quality of the high-yield bond market is of lower quality now than has historically been the case, despite valuations being higher than the average.
Stephen Snowden, head of fixed income at Artemis, says: “In the coming year the default risks in high-yield will certainly be greater than in investment-grade and than we have seen for some time. But we like all bonds at the moment.
"High yield just has different risk/reward characteristics. We get paid for taking risk. High-yield bond investors will have a more volatile journey but you will be rewarded for that. And good credit selection can mitigate risk.
"History clearly shows that when you buy at the double-digit yields possible today you end up doing incredibly well, helped by the power of compounding those returns. It will take dramatic capital growth in other asset classes to eclipse that."
Another consequence of the quantitative easing policies implemented by central banks was that yields dropped to record low levels, and bond prices rose.
As a result, fixed income investors derived most of their return from the asset class from capital gains, rather than income, while portfolio constructers traditionally view equities as being the asset to own for capital gains, and bonds as the income generating asset.
Krishnan says that while yields are higher, and this has helped drive investors into bonds in recent weeks, he also believes that current buyers have an eye on the potential for capital gain.
