Risk appetite returns to the high yield bond market

Despite the unremittingly negative economic background, 2009 has so far proved to be very good for high yield bonds. Inflows into the asset class have been strong, with investors attracted by the yields available varying from 11 per cent to 30 per cent.

Spreads, the extra premium investors demand to own European high yield securities over government bonds, have narrowed dramatically in the past few months, from a record high of 2,326 basis points at the beginning of the year, to a nine-month low of 1,397 basis points by mid-July. Thus, the sector has experienced month-on-month growth, with May alone returning more than 13 per cent. These conditions have helped revive the new issue market, and, after a long drought, companies have finally returned to the market to sell new bonds. Valletta Fund Management Limited launched the La Valette High Yield Fund in March 2006 to achieve a high level of income employing the expertise of Insight Investment, one of the largest UK-based portfolio managers with assets under management of £116.6 billion, of which fixed income and money market assets account for just over 80 per cent, or £93.8 billion, as at March 31.

The fund invests principally in bonds issued by sub-investment grade companies, which typically carry a higher risk of default. As such, the fund should be considered as presenting more risk than a fund which invests in either investment grade corporate bonds or government bonds. However, despite the "racy" reputation of high yield bonds, Insight Investment believes this high yield fund is very conservative in nature. The fund focuses on providing a solid income yield as opposed to chasing the high yield market growth by investing in very high-risk products.

Given the turmoil in global investment markets, the fund began the year on a defensive footing, with around 20 per cent being held in cash. Insight Investment did not seek to reduce the fund's allocation to cash too quickly as the market was, and still is, considered to be vulnerable to pull-backs. As sentiment improved, Insight Investment steadily reduced the cash position of the fund by adding some selected high yield names offering attractive risk/reward profiles, a few asset-backed securities and some higher-yielding investment-grade new issues. Thus, the fund has a good spread of assets with relatively high credit ratings, which have a much lower risk of default than the lowest-rated bonds. Investor sentiment has improved a great deal compared to the fourth quarter of 2008. The market has seen new investor inflows and there is growing liquidity. Increasingly, the market is taking the view that all the bad news is priced in, and providing securities are carefully selected, then the yields on offer present a good entry point. Given these newly-favourable conditions, Insight Investment expects to see more primary issuance as companies seek to reduce their reliance on bank debt.

On the back of this, it is difficult to see any weakening in the market, beyond credit-specific issues and profit-taking on names that have outperformed. However, defaults will undoubtedly increase. Therefore Insight Investment's strategy within high yield is to continue thoroughly researching and evaluating the different names available and to invest in the ones Insight Investment feels a high degree of confidence in while avoiding those which are most vulnerable to the deteriorating economy.

Insight Investment will look to take advantage of the new issue premiums available although we will continue avoid names we do not like from a fundamental credit perspective.

Valletta Fund Management Limited, Bank of Valletta's Fund Management subsidiary, is a joint venture between Bank of Valletta and Insight Investment. Some of the opinions expressed in this article are of a forward-looking nature and should not be interpreted as investment advice. Source: Insight Investment Management (Global) Limited.

Mr Moss is fund manager at La Valette High Yield Fund, Insight Investment Management (Global) Limited.