AllianceBernstein explains the rationale behind its latest products focused on emerging markets and high yield corporate bonds.
Another benefit is that CDS cannot be ‘called’, or redeemed early – again in contrast to many high yield bonds, which typically ‘trade to call’.
He says: “If a ten-year bond is callable after five years, the market generally trades it as though it is outstanding for five years. But if yields go up, the issue may not be called.
“We have not seen this ‘extension risk’ in high yield in any size because the environment has always been in the issuer’s favour to call the bonds and reissue at a cheaper rate.
“If an environment comes where the underlying yield rises enough, thus pushing spreads up, issuers may not want to call early. We can manage that risk through the CDS, which is not callable.”
AllianceBernstein’s fund is not the first such fund on the market, but Rudolph-Shabinsky says many more have not appeared already perhaps because high yield funds were sold on the basis of yield – while the new strategy has lower returns and compensates by reducing volatility.
He says investors should be careful their chosen manager is not concentrating on very short duration paper, which runs the risk of significantly narrowing their universe. Restricting to five years or fewer already cuts out one third of market volume.
Rudolph-Shabinsky has flexibility to buy longer duration bonds if attractive – as long as his fund’s average effective duration is four years or less. Alliance Bernstein’s other option for avoiding near-nil yield on core European debt, and logically high yields in peripheral states, is emerging market debt focused on Asian government paper.
The RMB Income Plus portfolio, run by head of fixed income Douglas Peebles, launched last May. It seeks its returns by income and long-term capital appreciation; top-down, bottom-up sector and security credit analysis; interest-rate management; and country and currency allocations.
Peebles invests in both RMB-denominated fixed-income securities issued outside mainland China, and non-RMB-denominated fixed-income securities of Asian issuers, issued by government or government agencies, or guaranteed by governments, supranationals or corporates.
All non-RMB debt – about 3% of the fund – is hedged back to yuan. AllianceBernstein forecasts 5.4% yuan appreciation in the coming year. Peebles looks beyond offshore Chinese debt – ‘dim sum bonds’ – for the sake of diversity, liquidity and quality.
According to Peebles, about two thirds of dim sum bond issues yield less than 2%, and there is a mismatch of supply and demand on this market that makes it risky to concentrate too many assets in it.
The fund is more heavily weighted outside China, to South Korea (35%), Indonesia and Philippines (about 16% each), India and Hong Kong (9%) and Malaysia (7%). It was two thirds investment grade and one third sub-investment grade.