What next for the high yield sector?

Following a mixed 2011, Maria Merricks asks fund managers what this year has in store for the high yield sector.

Last year was a game of two halves for the high yield sector. It kicked off with an encouraging corporate reporting season and continued smoothly for a few months against a supportive backdrop of quantitative easing and low interest rates.

But then came the storm. Summer was clouded by US and eurozone debt issues, sending markets into disarray. Months of extreme volatility followed, only to be further fuelled by credit rating downgrades across Europe.

Considering funds in the high yield sector must invest more than 50% of their assets in fixed income securities with credit ratings below BBB- (also known as junk bonds), it was unsurprising that the sector reported outflows towards the end of the year.

As investors fled riskier assets, a total of £7m left high yield funds in November alone, according to the IMA’s latest statistics.

Managers in the space, however, were pleasantly surprised by the level of outflows. According to Kenny Watson, manager of the Ignis High Income Bond fund, redemptions were somewhat insignificant compared to what had been expected.

And, as better than anticipated data from Europe and the US continues to lead December’s rally of risk assets into 2012, high yield managers are confident this year will be a good one all in all. However, that is not to say it will pass without its challenges.

Challenges ahead

The first on Watson’s radar is the impending results season, which European companies are just heading in to. But the impact of government austerity measures, and their knock-on effect on economic growth, is generally clouding his outlook for the first half of the year.

“It is going to be pretty tough and will be interesting to see if the market can hold its current level against that backdrop,” he says.

However, for Melanie Mitchell, co-manager of the Kames Capital High Yield Bond fund, the scenario looks rather more positive.

The ECB’s announcement in December on the Long Term Refinancing Operation (LTRO) under which close to half a trillion euros have been loaned to European banks, has made the risks more quantifiable than before, she says.

“Before the announcement we were facing the risks of both a recession and a European banking collapse. That scenario is so unheard of and unprecedented that to be able to predict what risk assets would have done is anybody’s best guess.