Tom Ross and Seth Meyer, co-managers of the Henderson Horizon Global High Yield Bond Fund, answer questions on their outlook for global high yield bonds.
What is your outlook for the high yield market?
Tom Ross (TR): The high yield market has performed strongly so far this year. In the first six months, global high yield bonds have returned 5.0%1. We were anticipating a full year return of around 5-7% in 2017 so we envisage performance in the second half of the year to be more muted given the strong early gains. Valuations are looking quite rich in some areas so we are taking a more cautious approach, since it is important to be able to justify an investment on an absolute basis and not just relative to other asset classes and other areas of fixed income.
1Source: Morningstar, 01.01.2017 to 30.06.2017, BofA Merrill Lynch Global High Yield Constrained Index, total return, hedged to USD.
Past performance is not a guide to future performance. Forecasts are estimates only and are not guaranteed.
Where are you currently finding the best investment opportunities?
Seth Meyer (SM): Within North America we are excited by opportunities in healthcare where relatively robust cash flows from the demographics of an ageing population are combining with capital discipline from companies that have faced a challenging political backdrop. We recently bought bonds in a new issue from Tenet Healthcare.
TR: In Europe, the removal of several key political risks in the Netherlands and France has made eurozone issuers more interesting. As an example, we increased our exposure to Telecom Italia at the end of May.
We have also been reducing risk on the portfolio, lowering the CCC weighting and buying selectively in the primary market in issues from names that have more predictable cash flows such as Burger King (France), the fast-food chain, and Netflix, the on-demand media company.
In which particular high yield market segments are you detecting the main risks?
SM: One of the advantages of a global approach is that we have the full array of issuers from which to choose. Clearly issuers and sectors share some cross-border characteristics but geography and the local economy often creates distinct variance. The US is further along the credit cycle than Europe so we are more cautious on cyclical areas in the US such as retail. We are also wary of raising exposure to emerging markets, given the rich valuations among many issuers and the pick-up in supply in this part of the market.
What are your expectations regarding defaults in the high yield market?
SM: The outlook remains relatively benign, with few areas showing signs of stress. Moody’s, the credit rating agency, has a baseline forecast that the global speculative grade default rate will be 2.3% by May 2018, which is actually down from the 3.3% rate at the end of May 20172.
2Source: Moody’s, correct at June 2017.
The shake-out in the energy complex in 2015, particularly in the US, meant that we went through a mid-cycle wobble, as oil-related issuers had to contend with a collapse in pricing. While the softness in the oil price has again led to nervousness in the sector we do not see any potential pick-up in defaults to be as severe as 2015/16 given the significant repair to balance sheets over the past 18 months. The widening in spreads challenges our underweight to the energy sector, but we believe that valuations are not yet compelling enough given the potential for further volatility in the oil price.
The next major test may be more policy-led as companies face a refinancing market in which central banks – the US Federal Reserve initially and maybe the European Central Bank later – begin to unwind some of their accommodative monetary policy. High yield has benefited indirectly from a cascade effect from central banks buying investment grade debt so it is hard to believe that high yield can be wholly immune from any reversal or tapering of this policy.
What is the current positioning of the strategy?
TR: The strategy is currently cautiously positioned: the yield and spread to worst of the strategy are both below the index, although duration times spread (DTS) is slightly ahead of the index. From a regional perspective, the strategy is positioned overweight both North America and Europe but underweight emerging markets. We believe the positive momentum in the North American and European high yield markets looks set to continue in the short term, but we remain reticent to increase our holdings in emerging markets given the rich valuations and relatively heavy supply.
The strategy is running a healthy cash position to take advantage of any potential interesting primary or secondary trade ideas. Although we are relatively sanguine on the global high yield markets in the short term, in the longer term we are cognisant that risks remain, which could change the current dynamics and induce volatility. Possibly of greatest threat is any tightening of monetary policy, which could instigate a weakening in investor sentiment and negatively impact global credit spreads. Additional risks include a resumption of the weakness in the oil price, which could particularly impact US high yield credit. Given this, we will continue to focus on using idiosyncratic risk and our strong bottom-up credit selection capabilities to drive returns.
What are the unique aspects of your strategy that sets you apart from the competition?
SM: One of the key differentiators of the strategy is that it is managed jointly from both sides of the Atlantic. The team in Denver and I focus primarily on North American high yield while Tom Ross and the team in London bring knowledge of the local market in Europe. With input from the emerging market team in London and a fixed income team in Australia, the strategy has all the key geographies covered. This helps to provide a genuinely global approach, capturing cross-border trends and helping to identify relative value opportunities.
Note: Reference to any specific company or stock is for information purposes only and should not be construed as a recommendation to buy or sell the same.