Thanks to investors hungry for better returns, high yield bonds have performed strongly over the last year. More and more companies are issuing corporate bonds in that space. But how long can the good times last?
Ahead of Investment Week's Strategic Bond Focus event on 25 February, Baillie Gifford Corporate Bond fund manager Torcail Stewart gives his take on the current state of the bond markets.
How did corporate bonds perform last year relative to other asset classes within the fixed income space?
Over the last year there has been a strong search for yield. The category of the market which performed most strongly last year was actually the lowest quality bonds within the high yield space.
But the yield on offer now for certain CCC bonds does not provide sufficient compensation for the long-term default rate. You have to be very careful which companies you choose to lend to these days.
Are you finding the best opportunities within high yield or investment grade at the moment?
Traditionally, you find the company that will make you more money within the high yield space. But, equally, you have got to do extra research because there is a higher risk of default. Our view is to have as broad a church as possible.
What do you say to those who think the high yield market has peaked?
The high yield market has seen growth, so there is a lot more choice of which companies you choose to lend to. This is particularly true of the BB-rated credit. There are a lot more opportunities for stock selectors to identify companies with improving balance sheets.
What is your outlook for the corporate bond market this year?
You are likely to see a number of new issuers. There are still opportunities within the market, particularly within the BBB and BB interface. We often find mis-pricings within that ‘betwixt and between’ part of the market.
The fund has a high percentage of asset-backed securities. Why are you so confident about this controversial sector?
We lend where you are lending to a single entity, such as Tesco Property Finance, a securitisation of the supermarkets that Tesco utilises. What is unusual is these bonds tend to trade at a higher yield relative to the unsecured Tesco bonds. You are higher up the capital structure, but you are actually getting more yield. That did not happen prior to the global financial crisis, but it has happened since.
What are the main headwinds for corporate bonds that investors should be aware of?
We have already seen a more than 1% rise in base rates in terms of the market price. That is quite a significant rise. Many are expecting it to rise further. It could choke off demand within the general economy.
Secondly, default rates are at an all-time low. The corporate bond fund straddles both investment grade and high yield. There is not as much duration in the fund as if, say, we were a vanilla investment grade fund. And we have not got the magnitude of default risk we would be likely to have if it was a pure high yield fund. We are seeking the middle ground. That is why we target the BBB and BB interface. Currently the fund is roughly 65% investment grade and 35% high yield.
Join us at the Strategic Bond Focus event on 25 February to hear more on these issues from our speakers. Click here for full details and to register to attend.
