The overheating asset class?

F&C’s Fatima Luis discusses the implications of high yield’s recent rise in popularity...

This year has seen record inflows into the high yield asset class, with $1.47bn invested in the asset class globally during the first week in April alone, reportedly the biggest weekly inflow ever recorded.

This has led some to question whether high yield is in danger of overheating, or whether it could now be considered as a more conventional and established asset class.

High yield’s recent ascent should not be too much of a surprise given the majority of the asset classes, including the so-called “safe havens”, have failed to avoid the impact of the economic events which began in 2007.

Add to the mix persistently low interest rates for a prolonged period of time and it is perfectly reasonable for investors to look at high yield as an alternative source of good risk adjusted returns and yield as well as low correlation with government bonds and equities.

Evolution

When considering high yield as an asset class, it is important to look outside the UK and Europe to the US. The US high yield market is now around $1trn in size and is considered to be established versus the high yield markets in the UK and Europe.

In the US, it is less of a stigma to go to the market as a high yield issuer as the US market is generally far more comfortable investing in corporates that are not able to obtain an investment grade rating, as this is typically reserved for only the largest of the corporates in America.

The European high yield market is around €200bn; this is a considerable rise from €25bn in 2002, at which point the European high yield market had been depleted following the fallout of the dot.com bubble.

Although the multitude of defaults around this time can be attributed to the collapse of the technology sector, this has continued to affect how investors view the sector in Europe despite the impressive rate of growth since this blip in its history. European corporates’ strong relationship with local banks has hampered growth and the banking crisis has proved to be a catalyst for corporates to seek lending elsewhere.

The evolution of the high yield market over the last few years has come courtesy of the credit crisis, albeit inadvertently. Where banks continue to deleverage and clear out loans from their balance sheet, the upside for the bond market as a whole is that the market has subsequently seen a great deal of refinancing come to the bond market.

This has consequently widened the high yield investment universe considerably and has given the investor far more investment opportunities than before. We believe that in turn investors, in our case as a high yield fund manager, can manage the credit risk much more effectively than ever before.

The more diversified the high yield market becomes, as it has been over recent years, the more we as investors can manage the bottom up credit selection process and make those sector calls more effectively, simply because there is more choice and transparency.