How to think about high-yield bonds right now

As bond yields rise investors can expect “some very good opportunities”, says Bill Bellamy, Director of Income Strategies at Pendal’s US-based investment manager TSW

• Bond yields high enough to consider investing
• Fundamental analysis is critical the further out the yield curve
• Find out about Pendal’s income and fixed interest funds

THE jump in bond yields this year has been stark, particularly in the high-yield end of the market.

US double-B rated bonds, for example, yielded 3.2 per cent at the start of the year and are now around 6 per cent.

But is that enough to make bond markets investable, given inflation rates globally are running at multi-decade highs?

Is it enough to look at high-yield investments, given the risk-reward trade off?

“Fixed income is, in our view, certainly much more investable today than it’s been for a while,” says Bill Bellamy, Director of Income Strategies at Pendal Group’s US-based investment manager TSW (Thompson, Siegel and Walmsley LLC).

“But we’re probably not totally done with this corrective phase and there is still room to go with yields. As they rise, there are going to be some very good opportunities.”

“Because the market has priced in a lot of the US Federal Reserve tightening that we think is coming, it’s time to take a look at fixed income markets once again,” Bellamy says.

Investing in fixed income involves interest rate risk, duration risk, industry risk and security specific risk.

But its main role in a portfolio is to provide ballast for stability.

“Investors want the ballast,” Bellamy says. “And investors can scale into the market as yields move higher.

“You may not pick the bottom, but you’ll get a better yield than what we’ve seen for some time.”

Returns don’t have to be spectacular because that’s not what investors use fixed income for — or as Bellamy puts it: “we’re trying to hit singles and doubles, not triples and home runs.”

While the philosophy across fixed income markets is the same, as investors move out the yield curve and go beyond investment grade to high-yield double B rated bonds, or single B or triple C, it becomes more of an individual credit picker’s market. It is an area of expertise for Bellamy.

Income cushion

High-yield bonds offer an income cushion that investment grade bonds and Treasuries do not, he says. The main risk in high yield is default risk.

“In high yield bonds, you need to do fundamental analysis of the underlying credits ultimately going into a portfolio.

“You need to know what the ultimate risk is in the event of a problem at corporate level. You need to know anything that could impair your ability to get your money back,” Bellamy explains.

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Pendal’s Income and Fixed Interest funds

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That groundwork understanding the ultimate asset of a high-yield bond isn’t just a safety check. It also unveils mis-priced assets.

“Is the market efficient in that respect? We don’t think so,” Bellamy says. “We believe the ratings agencies leave a lot of opportunities in the high yield market especially as you go out the risk spectrum.

“That’s particularly so when an issuer might have one or two issues outstanding. That’s really where you can uncover some opportunities from an investment perspective.”

“When investing in fixed income, we believe that income wins over time. We try to outyield the indices in the most efficient way possible.

“We are a big believer in getting paid for the risks we are taking.”