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Mitigating risk in a high yield bond portfolio

Holding bonds with short maturity dates or which are likely to be refinanced will enhance returns and reduce volatility in a sub-investment grade bond fund, according to Insight's Ulrich Gerhard.
Ulrich Gerhard, Insight Investment

“The bond issues must also be underpinned by companies with stable and predictable cashflows to avoid fund drawdowns,” Gerhard told FSA in an interview.

He pointed to the performance last year by the $689m BNY Mellon Global Short Dated High Yield Bond Fund he co-manages with Alex Veroude at Insight Investment, which is one of the so-called autonomous boutiques owned by BNY Mellon Investment Management

According to FE Analytics data, the fund ended more or less flat (-0.08%) in calendar year 2018, despite the sharp market sell-off in Q4, compared with an average decline of -4.87% by the global high yield sector. Bank of America Merrill Lynch figures for the year to end-December show a positive 1.24% return by short-dated high yield bonds (with maturities of one year or less), outperforming other junk bond categories, such as US high yield (-2.26%) and global high yield (-3.34% in US dollar terms).

The fund, which is authorised for sale to retail investors in Singapore but not in Hong Kong, has a three-year cumulative return of 11.21%, exceeding the return of its global high yield category average (5.95%) and its benchmark, US dollar 3-month libor (4.68%), according to FE. Typically, income comprises most of the redemption yield of the fund, which was 5.15% at the end of March when the most recent quarterly distribution was made.

Annualised volatility since the fund’s relaunch with the US dollar as its base currency in November 2016 (previously it was sterling-based) is 2.09%, lower than the 3.43% sector average.

Its performance was lifted by purchases of short-dated high yield bonds which flooded the market late last year. Some mutual funds were forced to offload holdings to meet unit sales, providing opportunities for other funds with cash available to pick up bargains, as Eoin Walsh, portfolio manager at Twenty Four Asset Management, told FSA in January.

Refinancing potential

“We buy bonds that have short final maturity dates and bonds that are likely to be called by the borrower within 12-to-24 months and refinanced,” said Gerhard.

“So our team of analysts in the US and Europe try to identify those companies that might have their credit rating upgraded, are preparing a capital restructuring that might induce them to redeem their bonds early or have bond covenants that restrict other activities, such as paying dividends, and which might compel them to call the issue.”

The portfolio holds about 85 individual issues with an average maturity date of 1.4 years and credit rating of B+, according to the fund’s fact sheet. It also has an approximately 15% allocation to other short-dated securities, including credit default swaps, syndicated loans, trade finance instruments, convertibles, asset-backed securities and emerging market bonds.

Its exposure is almost entirely to the US and Europe — where the credit analysts are present – although Gerhard said that there are plans to increase coverage of Asian high yield bonds, including China property issues.

“However, as part of our screening process, we only buy hard currency bonds, and the companies that issue them must have hard currency revenues to service the debt,” he said.

Gerhard insisted that the fund has avoided the worst impacts of any corporate debt defaults, despite the average annual high yield bond default rate of 3% since 2014 (according to Moody’s Investors Service).

“There were couple of instances where we were nearly hurt, but we got out in time or else we recovered our initial losses in the subsequent restructuring,” he said.

Gerhard expects the global economy to slow this year, so he is likely to focus on defensive sectors and avoid growth companies.

“But, as usual, we will prefer companies with predictable cash flows that will service their interest payments and those that are likely to redeem and refinance their existing bonds,” he said.


BNY Mellon Global Short Dated High Yield Bond Fund vs 3 month USD libor benchmark and global high yield sector average

Source: FE Analytics. Cumulative performance in US dollars since re-launch of fund with US dollars as base currency.

Part of the Mark Allen Group.