now loading...
Wealth Asia Connect Middle East Treasury & Capital Markets Europe ESG Forum TechTalk
Asset Management / Wealth Management
Why high-yield bonds still provide better opportunities despite tighter spreads
While fundamentals remain strong, rapidly rising inflation is the main risk facing high-yield bonds
Bayani S Cruz 22 Mar 2018

US high-yield bonds still provide good opportunities for Asian fixed income investors despite rising interest rates. Although credit spreads have become tighter, US high-yield bonds remain reasonably priced.

In fact, the high-yield bond sector has outperformed the investment grade bond sector so far this year, based on the average spread of the Morningstar Corporate Bond Index which has widened by 13 basis points since the beginning of the year.

The strong performance and bright prospects for high-yield bonds are underpinned by strong economic fundamentals that continue to support the global economy, despite concerns of a rising interest rate environment that may have a negative impact.

“The fundamentals are very good. We’ve got a period where the major economic regions globally are all doing quite well and we think that still makes for a very good story, especially when it relates to credit. Credit spreads are tighter than they were a year ago. But if you look at where the economy sits compared to a year ago, they seem to be reasonably priced from that perspective,” says Michael Freno, managing director and head of Global Fixed Income & Multi-Asset at Barings.

Because of the strong economic fundamentals globally, Barings believes the incidence of increased corporate defaults in the market is relatively low for the next three months.

“We think we can pick some higher-yielding assets, rather than moving up in the ratings spectrum,” Freno says.

The main risk facing high-yield bonds, and corporate bonds in general, is an unexpected rapid rise in inflation.

“The inflation story will be the one that bears itself out. That’s where we think the biggest risk is if inflation does come in much quicker than we’re expecting, or much quicker than the Fed’s expecting, or than the market is expecting. That has the opportunity to really slow things down and add a lot of volatility,” Freno says.

In terms of investment strategy, Barings focuses on shorter-duration bonds which are non-investment grade. This means bonds with a single-B or double-B credit rating.

“We think that’s a more inefficient part of the market, so as credit pickers and as stock pickers we think that’s where we can add the most value,” Freno says.

This strategy is particularly evident on the European portion of Baring’s portfolio where on average the high-yield bond market (in Europe) tends to have a higher credit rating in the longer duration bonds when compared to their US counterparts. In general, the spreads in the European high-yield market are also much tighter than the spreads in the US.

Because of this Barings focuses on investing in European single-B credit because the spreads in this market are equal to the spreads of the single-B market in the US. Single-B spreads are currently at 350-375 basis points.

“Our strategy is this, we’re very much a bottoms-up credit shop particularly on high-yield where we have less duration than the overall market does (in high-yield),” Freno says.

Barings has US$220.1 billion in fixed income assets out of US$304 billion in total assets.

Photo: Vintage Tone / Shutterstock

Conversation
Arsa Indaravijaya
Arsa Indaravijaya
deputy secretary-general and chief investment officer
Government Pension Fund Thailand
- JOINED THE EVENT -
17th Asia Bond Markets Summit
Resilience in an age of uncertainty
View Highlights
Conversation
Anupam Misra
Anupam Misra
head of corporate finance
Adani Group
- JOINED THE EVENT -
6th ESG Summit
Beyond the hype
View Highlights