Hold your nerve in high yield

Credit spreads – the difference in yields between corporate bonds and the safest government bonds – in parts of the market have widened to as much as 800 basis points on US recession fears and other perceived problems. Widened spreads are seen as a risk indicator and cause many investors to sell.

However, such “fear and loathing” also creates buying opportunities, says Bus, manager of Robeco High Yield Bonds. The fund has actually increased its risk-adjusted market exposure, or ‘beta’, on the strong belief that returns will come to those who are patient.

“The market has turned more bearish in recent weeks and spreads have increased, so we see even more opportunities now,” he says. “We have increased the beta of the portfolio to an overweight position of 1.1. We are always looking for fear and loathing – it always creates a buying opportunity.”

Three things fueling volatility
Bus says three things are fueling volatility: fears of a US recession, the continued low oil price hurting ‘petrodollar’ funds with lower revenues, and the notion of a new banking crisis in Europe after negative headlines about some individual banks.

The elements that are fueling this are led by the weak economic data; mostly in Asia but also in some developed markets. These are indicators that make people wonder if there is going to be a recession in the US.

We see real money selling in the market, but mutual funds do not report big outflows. We believe that the selling pressure probably stems from petrodollar sovereign wealth funds. And there is some fear of a new banking crisis in Europe. We strongly disagree with the notion that a new banking crisis is in the making.

‘Indicators make people wonder if there is going to be a recession in the US’
It is very difficult to predict if there will be a US recession or not, so we’re not going to try to do that. What we can say for sure is that a potential recession is already priced into the current spreads; they are not as high as in 2008, but they are at levels which are associated with recessions. Only an ‘Armageddon situation’ has not been priced in, but that’s not what we expect.

The outflow of petrodollars from countries hurt by low oil prices will eventually flow back into the pockets of European and US consumers. They will either spend it, which is good for the economy, or they will save it, and then it will find its way to capital markets somehow. It only takes a bit more time – this is a transitional phase.

As for a banking crisis, fundamentally the banks have not really deteriorated – it’s just sentiment making things worse due to issues with some specific names that have emerged in recent weeks. Commodities are improving Malaise in the commodities market led by fears of a Chinese slowdown was a major cause of volatility in 2015.

But there are some positive signals in the market now: iron ore prices have been going up after reaching their low in December, so that could be a signal that there is
some recovery in China,” says Bus. We also see that some sectors are entering the next phase of the credit cycle by engaging in balance sheet repair. It’s a more conservative phase after years of financial engineering that can lead to bubbles and risk taking.

We’re actively looking for opportunities in sectors where the sentiment or management behavior is changing for the better for bondholders. that while there While there are opportunities out there, our fund remains careful to try to pick the winners and avoid the losers. Our financials exposure is small at around 4% of the fund’s value, and we invest only in the higher-quality banks, which is a great addition to diversify the portfolio and enhance performance.

We have very limited exposure to the riskier bank Contingent Convertible (CoCos) of less than 0.5%. In oil we have been reducing our underweight in the sector by adding the higher-quality names. We remain underweight on the lower-quality energy names. In metals and mining we have moved to a small overweight because there we feel that the consensus has become too bearish and metal prices are no longer falling.

We are still long Europe versus the US, which is mainly the result of sector preferences and the fact that we still want to be underweight the segment rated CCC, which is much bigger in the US. We have very limited exposure to the riskier bank CoCos.   We are also careful with China related companies; those that make a big part of their revenues in China.

But you can never say never for any company. At current yield levels, so long as we avoid defaults, we can make a very good return in the coming few years. In a nutshell: The total return outlook is very positive for investors who are able to withstand day-to-day volatility, which we believe high yield investors should be able to do anyway. It’s a long-term market, and this is a great entry moment for investors who keep their nerve.

Sander Bus, portfolio manager, Robeco High Yield Bonds


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