High-yield bonds remain in demand among investors whose main focus is on absolute returns, this week’s Morningstar Fund Radar shows.
After a rally in fixed-income bonds in the last quarter of 2023, more defensive bonds, such as those issued by governments or with longer maturities, underperformed the credit sector, including high yield.
This is mainly due to prolonged uncertainty around the timing of future interest rate cuts, while the expected default risk for high-yield bonds, while rising, remains limited. Previous concerns that higher interest rates would severely affect the private sector were thus largely misplaced.
The Morningstar Global High Yield Bond index posted a positive year-to-date return of 5.2 per cent in euro (12.2 per cent over the past 12 months) while euro and dollar investment-grade bonds with maturities of 10 years or lower corrected. The asset class remains popular among European investors and this is mainly due to its initial yield. After all, the ICE BofA Euro High Yield Option-Adjusted Spread, the compensation for credit risk in high yield bonds has been on a downward trend since October 2023 (493 basis points) when bonds were pushed up by expectations that the Federal Reserve would proceed with interest rate cuts in 2024.
Another low (313 basis points) was reached in early June to close the quarter at 353 basis points. A similar move took place in the US and the effective yield on the ICE BofA US High Yield Index stood at 7.7 per cent at the end of last month versus 6.1 per cent for the European equivalent.
Source: FRED, Federal Reserve Bank of St. Louis.
Preference for safer issuers
As of end-June 2023, the spread on BB US high yield bonds was 185 basis points, barely higher than the 119 basis points offered in BBB-rated securities. Hence, some fund managers also partially included these investment-grade corporate bonds in their high yield portfolio.
Spreads for the riskiest high-yield credits, those rated CCC or lower, rose to 953 basis points in the US, and the spread between BB and CCC rose further showing that investors are increasingly concerned about weaker companies. Indeed, these could lose access to funding and default on their debts in a situation where borrowing costs remain high. So the focus of high yield investors today is more on avoiding problems than making extra returns.
Barings Global High Yield Bond
The strategies that appear prominently on Morningstar’s radar either possess a strong management team and a robust investment process in the qualitative judgment of fund analysts, or these qualifications are attributed based on an algorithm that evaluates mutual funds based on the same framework. In this article, we highlight a fund that meets these criteria and is followed by Morningstar analysts.
Barings Global High Yield Bond gives investors access to an experienced management and analyst team that takes a well-defined and team-oriented approach. The consistently applied investment process has delivered attractive absolute and risk-adjusted returns since the fund’s inception in 2012. Moreover, outperformance has been very consistent and it is also positive to see that both bottom-up security selection and top-down geographical allocation have been able to add value over time. Morningstar analysts started following this strategy last year and rewarded it with an Above Average rating for both the People and Process pillars.
Graig Abouchar and Scott Roth are the lead portfolio managers. Both boast nearly 30 years of investment experience, and Abouchar and Roth joined Barings in 2016 and 2002, respectively. Abouchar focuses on European-based positions while Roth focuses on the US.
The strategy also has three co-managers: Sean Feeley (since 2012), Chris Sawyer (since 2016) and Chris Ellis (since 2021) with Ellis being the backup for Europe and Freely for the US. The managers are supported by 31 analysts organised by region and sector and benefit from the input of the Global High Yield Allocation Committee as well as the 10-member team responsible for special situations.
The strategy follows a bottom-up-oriented process. Credit selection is driven by two investment committees, one for US high yield bonds and one for European high yield bonds, both of which meet daily. The experienced team members vote to approve analyst recommendations and include them in a buy list or impose the sale of certain securities. Top-down input comes from the Global High Yield Allocation Committee, which meets biweekly and decides on allocation targets between the US and Europe.
The strategy is benchmark-agnostic and can take significant positions that differ from those of the index in terms of sector and rating category allocations. Duration is traditionally not an active source of alpha and is kept within a six-month range.
Thomas De fauw is manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds based on quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners.