NB stresses downside protection for euro HY bond funds

Asset Class in Focus

Understanding credit risk is the key to managing a high yield euro bond fund, according to Neuberger Berman’s Vivek Bommi.

Vivek Bommi, Neuberger Berman

“The rise in yields towards the end of last year provided opportunities to buy some European corporate bonds at historically high rates, but understanding downside risks is essential, especially as global economic growth slows,” said Bommi in an interview with FSA during a recent visit to Hong Kong.

He focuses on a company’s free cash flow, gearing ratio and interest cover, and also its potential for a credit rating upgrade.

The Neuberger Berman European High Yield Bond Fund, which he runs as senior portfolio manager, has a slight overweight position in single-B credits where he sees steady improvement in their financial strength, but has so far avoided — or was able to bail out of in time — bonds whose credit quality deteriorated sharply.

“There have been 30 European bond defaults in the last two years: we didn’t own 27 of them and sold the three that we did at par value,” he said.

Red flags he looks for are a significant increase in leverage and a failure to generate cash, not just to service the debt, but to operate the business in a sustainable way.

The $26m fund has achieved a 24.8% three-year cumulative return, according to FE data, outperforming both the European fixed income and high yield sector averages, but in line with its benchmark index (Bank of America European Non-Financial High Yield 3% Constrained Index).

Its returns have an annualised volatility of 3.05% over the three years, half the volatility of the European fixed income sector average, according to FE.

Hedged enhancement

European sub-investment grade bonds (BB+ or less) remain attractive relative to US equivalent credits, according to Bommi.

However, the disparity and appeal is caused more by the difference between negative-to-zero ECB interest rates and a US Federal Reserve target rate of 2.5%.

The hedge adjusted yield premium is about 100 basis points (bps) for BB bonds and as much as 230bps for single-B issues due to the positive carry earned by hedging into higher interest earning US dollars.

The biggest risk to the high yield bond sector in general would be a worsening of macroeconomic conditions, said Bommi.

As a result, his fund is likely to remain overweight non-cyclical credits such healthcare – yet it is also overweight bonds in the media and capital goods sectors which are vulnerable to a downturn in the economy. The fund holds no bonds in the financial sector.


Fund characteristics

 

Fund

*Benchmark

Weighted average maturity (years)

5.63

5.29

Weighted average yield to worst USD (%)

6.84

7.42

Weighted average duration (years)

2.82

3.67

Weighted average current yield (%)

4.42

4.47

Weighted average credit rating

BB-

BB-

Source: Neuberger Berman. *BofA Merrill Lynch European Currency Non-Financial High Yield 3% Constrained Index.

Sector Allocation

Sector

Fund %

*Benchmark %

Media

16.02

10.71

Capital goods

12.33

7.79

Basic industry

10.63

13.38

Healthcare

10.39

7.18

Retail

9.91

10.07

Source: Neuberger Berman. *BofA Merrill Lynch European Currency Non-Financial High Yield 3% Constrained Index.

NB European High Yield Bond Fund vs Category Averages

Source: FE Analytics. Three-year cumulative performance in US dollars.

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