After two consecutive red quarters, global high-yield bond funds closed the third quarter with handsome gains. Yet it is premature to speak of a trend reversal.
High yield bonds outperformed long duration assets this year. On the one hand, interest rate sensitivity is playing its part and, on the other, the market seems little concerned about credit risks. The global high yield bond Morningstar Category showed a gain of 4.3 per cent over the last three months. This brings the year-to-date return to -2.8 per cent. The ICE BofA Glb High Yield Constrained Index closed the third quarter with a gain of 3.9 per cent measured in euros but is still 5.8 per cent below its year-end 2021 level. Moreover, it should be noted that the gains in the third quarter can be attributed to a rally in July and August, but in September the index lost 2.4 per cent again. So we cannot speak of a trend reversal.
No panic, but focus on quality
Although credit risks increase during an economic recession and portfolio managers respond to this by focusing mainly on quality, there is little evidence of panic. Neither does Per Wehrmann, manager of the DWS Euro High Yield fund, which is rated Silver by Morningstar analysts. His expectation is that defaults in Europe are likely to remain below their long-term average, as many companies refinanced their debt in the past two years, extending their maturities on favourable terms. Moreover, the quality of the high-yield bond market has also increased in recent years.
The current prices therefore offer investors interesting returns, according to the experienced investor. DWS is currently overweight more risky credits such as those rated CCC and remains underweight BB rated bonds and more interest rate sensitive securities. Cyclical issuers with longer-term challenges are largely avoided, as are companies within the cyclical consumer goods sector (such as the auto industry and some retailers).
Higher yields, stable spreads
The ICE BofA US High Yield Index Option-Adjusted Spread closed last quarter at 543 basis points, slightly lower than the 587 basis points at the end of June, but still higher than the 310 basis points at the end of last year. As government bond yields continued to rise during the third quarter and spreads did not change much from mid-2022, the effective yield on the eponymous index did rise to 9.5% at the end of September. The European equivalent clocked in at 8.15%, also up over the last three months.
Future remains uncertain
Nevertheless, caution remains necessary because, as is often the case with credit, no one has the full picture. Presumably, many riskier loans during the fat years were made in the then-popular private market. It is difficult to estimate how vulnerable loans are there and whether that could have an effect on the broader (public) market.
Furthermore, it remains difficult to estimate how inflation and economic activity will evolve further and how central bankers will respond. The key question for high-yield bonds is (given the inherent credit risk) whether a recession is already fully priced in or spreads still need to rise further.
Top-5
For this week’s Top-5, we look at mutual funds in the Morningstar Global High Yield Bond Category whose distribution fee-free fund class is available in the Netherlands. These five funds have shown the best performance based on returns over the first nine months of 2022.
UBS (Lux) Floating Rate Income and M&G (Lux) Global Floating Rate High Yield Fund remain at one and two in our list as at the end of last quarter, while Robeco’s high yield bond fund slipped into the top three. The UBS strategy alternated strong with not so strong years. It finished in the first and second quintile in 2018 and 2021, but landed in the lowest quintile in 2019 and 2020. The fund is managed by Matthew Iannucci, Anaïs Brunner and Branimir Petranovic. Iannucci, the global head of high yield developed markets has worked for UBS for 26 years and is based in Chicago. Brunner and Petranovic have also worked for the Swiss asset manager for many years. The fund had 60% of its assets in bonds maturing in less than three years compared to a category average of 23%. About 4% of its assets were invested in the UBS (Lux) Short Duration High Yield Sustainable strategy.
Rotterdam-based Robeco also rejoined the list with their Robeco High Yield Bonds fund. This strategy is managed by Sander Bus and Roeland Moraal and the two receive the highest accolade from Morningstar analysts for their work on Robeco European High Yield Bonds, namely a Morningstar Analyst Rating of Gold. Fundamental credit research is carried out by Robeco’s credit team, which includes both investment-grade and high-yield bonds. This team has expanded to 21 analysts over the past six years. In the third quarter, the managers increased the beta of their portfolio and stand ready to increase credit risk should spreads rise further.
Top 5 High Yield Bonds YTD (as per NL fund class)
Top 5 High Yield Bonds YTD (as per BE fund class)
Thomas De Fauw is a manager research analyst at Morningstar. Morningstar analyses and evaluates investment funds on the basis of quantitative and qualitative research. Morningstar is one of Investment Officer’s knowledge partners and ranks five investment funds or providers each week.
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