Bond Traders Reach for Yield

Terry Flanagan

High-yield bonds remain attractive even as investors clamber aboard the equity bandwagon that has seen the Dow push past the 15,000 level.

“I trade high-yield on a daily basis,” said Wes Sparks, head of U.S. fixed income at Schroders plc, which has $35 billion in assets under management in U.S. fixed income. “High-yield valuations are boosted by the reach for yield.”

Global high-yield issuance in 2013 has totaled $154.6 billion to date, according to Mischler Financial Group.

A confluence of secular trends is working to keep high-yield bonds in demand as the first half of 2013 nears a close.

“Investors and asset allocators will continue to be attracted to the yield of the global high yield and emerging markets sectors, and there won’t be a significant rotation out of credit into equities in 2013,” Sparks said.

Monetary policy remains highly accommodative to offset the impediments to economic growth from more restrictive fiscal policy in the US and Europe. There are ongoing quantitative easing programs by the Fed and other central banks around the world. Inflation and inflation expectations continue to remain subdued.

“The trend [toward higher valuations for high-yield] is being driven by central banks reducing systemic risk and the deflationary spiral,” Sparks said. “Spreads and yields are reflecting the environment we face today.”

High yield bonds produced returns in the high teens, beating all other fixed income sectors as well as most equity indices in 2012. While the absolute level of high yield bond returns will most assuredly be more modest in 2013, returns relative to other asset classes may still look strong. “There should be more opportunities for the active investor to add value by selecting the right credits and the right industries to invest in,” said Sparks.

Increasing regulation, alongside continued uncertainty in the sovereign and credit markets has accelerated the demand for more efficient, informed and connected execution venues.

MTS, a European electronic fixed income marketplace that’s controlled by London Stock Exchange, plans to launch a platform for U.S. institutional investors. The platform will enable U.S. buy-side participants to execute European and U.S. government, agency, mortgage, and corporate bonds with major dealers.

The launch of the U.S. dealer-to-client marketplace later this year will enable clients to benefit from price transparency provided by a deep pool of dealer liquidity and comes at an important time for the industry.

“Building out our fixed income presence in the U.S. is a natural extension for MTS and London Stock Exchange Group,” Jack Jeffery, CEO of MTS Markets, said in a statement. “By expanding the reach of our pricing and trade execution, we are not only responding to the on-going regulatory push for greater transparency and efficiency, but providing an attractive, competitive and cost-effective alternative to an important community of institutional investors.”

Sparks co-manages the Schroder Total Return Fixed Income Fund. Higher yielding sectors outside of traditional investment grade corporates were in high demand for the extra income and falling risk premiums, the Fund reported at the end of 2012. U.S. high yield corporates posted a 3.28% excess return and U.S dollar denominated emerging market bonds had a 3.26% excess return.

In seeking returns in 2013, Schroders is more inclined to move down the capital structure and invest in subordinated debt of better quality companies than to move down in credit rating to invest in weaker companies to pick up yield.

“Issue selection will likely play a greater role in generating returns in 2013 than has been the case in recent years when a “risk-on/risk off” mentality drove valuations across financial markets and kept correlations of price returns high,” Sparks said.

Related articles