There is no doubt that fixed income and in particular high-yield credit has done very well in recent years. As Tom Beckett, Psigma CIO, pointed out on Monday, despite already having the lowest yields in its history: “the asset class formerly known as 'high' yield credit has been one of the best performing asset classes, as yields have gone from very expensive to eye-wateringly expensive.”
And, he says, although there has been a slight cooling of sentiment over the last two weeks, appetite for risky corporate bonds remains insatiable. Part of that cooling in sentiment came on the back of concerns raised by Fed Chair Janet Yellen, about the liquidity of some of these investments.
This is a topic raised at Portfolio Adviser before, not least of which by BlackRock’s Michael Fredericks who said there was a concern that investors could have been lulled into a false sense of security and, when they do try to get out of some of these more illiquid assets they may struggle to do so at a price they would like.
According to Beckett this is a concern Psigma has also had. Citing an article released by Morningstar recently, that suggested the utter collapse in the role of 'market-makers' could lead to a mismatch of sellers and buyers if the appetite of yield-starved investors was to swing the other way, Beckett explained: “In the past the 'broker-dealers' who served as market makers would act as a liquidity buffer to mop up excess supply. However, now the financial world is run by risk-managers and because of the onerous regulation contained within the Volcker package, the previous roles are all but prohibited and investment banks embrace the 'broker' part of the role, but are terrified to be 'dealers'.”
So far, he says, this has not created a major issue, but he feels it is “an underestimated risk which stalks all asset markets, not just corporate credit markets”.
AXA’s Chris Iggo, however, is less concerned on the whole, saying he is not worried about wholesale selling of investment grade in any kind of market environment that leads to an increase in spread volatility.
“It does not seem to me that the investment grade market has been a popular destination for the kind of money that exits at the merest hint of a turning point”.
But, he does say that high yield is more of a concern in that regard.
“To me, any volatility in high yield driven by outflows is consequence of asset allocation decisions that are a result of valuation concerns and also by the fact that many investors might be looking at high yield and equities and thinking that returns have just been too good. Recent news has not been conducive to staying with the risk-on trade and certain news stories could get worse, impacting investor confidence.”
For M&G’s James Tomlins the key question is going to be the manner in which central banks turn the interest rate cycle. “We get the sense that we are at a crossroads with interest rate risk. The Fed and the Bank of England have indicated the rate cycle is turning and there is always the question of whether high yield can cope with a bearish outlook for government bonds. We believe it can as long as the adjustment is slow and orderly and Carney and Yellen seem very keen not to shock the markets.”
But, he adds: “Whilst the low interest rates of recent years have seen a hunt for yield, which has had an impact on the standard of lending to the market, we still believe that we are being adequately compensated for the risk we are being asked to take and so from that perspective we do not believe we are seeing a bubble in high yield.”
