In the search for yield, some high yield investors are shifting to a broader mandate to invest in “below B”, the riskiest segment of high yield. PGIM recently repositioned two high yield funds to invest in CCC and CC bonds.
Until recently, PGIM’s European and US high yield funds only invested in corporate bonds with a credit rating of B or BB. In the past few weeks, both funds have also been allowed to invest in the sub-investment grade spectrum of corporate bonds. In other words: below B.
PGIM’s choice was prompted by the lagging scale of the funds and the desire to be able to give them an ESG label. Since the sustainability requirement meant that some of the loans were cancelled, the mandate needed to be broadened in other areas.
“The funds had scale, but not the scale we were hoping for,” explained Yvo van der Pol, who is responsible for the Benelux and Nordics region at PGIM Investments, PGIM’s fund distributor. The US fund, which was established in 2020, had a size of almost EUR 78 million before the conversion, the European version from 2018 EUR 38 million.
In addition to the aforementioned expansion into the higher yield segment and the ESG implementation, the fund house with USD 1,500 billion under management also decided to make the US fund a global fund. According to Van der Pol, this was because PGIM felt there were too few high-yield corporate bonds available in the US with a high ESG score.
Whether the choice for higher-yield investments is an answer to the search for yield, “the needs of the incumbent clients have indeed changed”, said Van de Pol. “The two high yield funds were set up a few years ago for a specific institutional client group that was not allowed to invest too much risk in high yield according to compliance and/or regulations.”
Convert or start over
There are several reasons why the asset manager opted for a conversion of existing funds instead of setting up new funds. “If you start again,” explained Van der Pol, “you first have to raise seed capital, have shelf space, build a track record. In the first few years, you are invisible. Then it is a product-development consideration: do you choose a new start, or do you convert an existing fund? Converting can be done very quickly: with a prospectus change and regulatory approval, you can change a mandate with the approval of the largest shareholders.’
The risk of incumbent clients wanting or having to leave the fund was there, he agreed, although in this case it was less of a problem because there was not yet so much capital in the funds. In practice, moreover, the new mandate was only unsuitable for “a few”, according to Van der Pol. “But the majority of the clients had progressive insight in this situation. They ultimately chose to stay put.”
He emphasised that it is not only the broadening of the high yield segment that can be a consideration for whether to stay in an adjusted fund. The implementation of ESG investing, he said, can also be a reason for investors to leave a fund.
“Not every party worldwide is as ESG-minded as we are in the Benelux and the Nordics, so this is an important condition. As a provider, you run the risk of a large shareholder withdrawing money. If there is sufficient demand in the market, it may be better to opt for a new fund and build up a new track record.”
Risk management
Meanwhile, the benchmarks and the investment universe of the two funds have been adjusted, as well as the risk profile, in close consultation with risk management. “If an investment policy changes”, Van de Pol explained, “very large changes can be made to the portfolio. Incidentally, this is not a complete turnaround from one day to the next. You don’t want to be forced to be a big seller in a tight market. You have to take into account your liquidity and the market developments.”
The result is two funds that aim for higher yields in high yield corporate bonds, but expect slightly lower returns at the bottom line. This is due to the previously mentioned ESG filter, which excludes part of the universe. ‘There are times when ESG funds do better than non-ESG funds”, said Van der Pol. “But when certain sectors are performing strongly (such as the energy sector at the moment), as an ESG investor you are sometimes worse off. Ultimately, I think, like PGIM, that everything is moving more and more in the ESG direction.”
On how PGIM Fixed Income applies ESG investing, he said the fund house does not believe in using only external ESG data. “Instead, we work with an ESG committee of seven analysts who support and advise our analysts in giving ESG impact ratings from 0 to 100. At the moment, they have given over 100,000 ratings across the fixed income universe.”
An investment analyst (of which PGIM has 125 worldwide) then gives a financial rating and decides whether to buy or sell a loan. Van der Pol explained that “Each purchase is a joint effort between the ESG committee and an analyst, but the analyst takes the lead. Each issuer in the portfolio must have an ESG score of at least 40 and on average the portfolio must have a score higher than 50 and at least higher than the benchmark. High yield companies, and certainly those in America, often fail to reach 40.”
About PGIM Investments
PGIM Investments is growing rapidly in the Benelux. Whereas two years ago Yvo van der Pol joined the newly established Amsterdam office as its 13th employee in Europe, the fund distributor now employs almost 50 people.
The asset manager has been offering UCITS funds for more than five years, now about 30 in total. Twenty of these are bond funds. A large proportion of PGIM’s funds have been launched or ‘re-ESG‘d’ as ESG funds. In the coming period, PGIM will bring a ‘considerable number’ of new funds to the European market, according to Van der Pol.
Of the 1,500 billion dollars under management, about 10 billion dollars are in the UCITS funds. In addition, the fund house manages mandates, also for a number of Dutch parties. “So ultimately our interest, including mandates in Europe, is a multiple of that 10 billion,” explained Van der Pol.