Schroders’ Wesley Sparks has been building an allocation to investment-grade debt within his high-yield fund, but said a correction for bonds will not precipitate a longer-term bear market.
Mr Sparks, who manages the firm’s $2.7bn (£2.1bn) ISF Global High Yield fund alongside Martha Metcalf, said he was gearing up to deploy cash amid any correction.
The fund is holding ‘dry powder’ in the form of investment-grade bonds and short-term US Treasury bills in acknowledgement of a potential need for greater liquidity. Mr Sparks added he was eager to deploy capital in a better environment.
“Some people are saying fixed income is in a bubble, but credit spreads are in the fair value zone looking at compensation for expected losses due to defaults,” he said.
“The market is pricing in about 200 basis points of risk premium – in the past we have seen that inside 100. If we got to that level, I would say that’s a screaming sell signal.
“[The market] is not a sell, but valuations aren’t compelling and there will be a better point to rotate out into a more aggressive trade. Hopefully that develops this quarter, but we [would] need something that shatters sentiment.”
Despite the caution expressed by Mr Sparks and Ms Metcalf, performance of the fund has not dropped off compared with its peers.
The vehicle has returned 10 per cent over the past year compared with an average of 3.7 per cent for the IA Global Bond sector. Mr Sparks said the fund’s investment-grade holdings had aided returns.
Although the focus of the fund is on high-yield debt, the managers are allowed to hold up to 30 per cent of their portfolio in non-junk debt – including derivatives and investment-grade bonds. This flexibility has seen the team build up an 8 per cent holding in BBB-rated corporate debt.
Mr Sparks explained that some low-end investment-grade debt exhibited better risk-and-reward metrics compared with the best end of the high-yield market. Investment-grade debt’s better liquidity profile, and its occasional role as a non-correlated asset, also played a part in the decision.
“We haven’t favoured BB [-rated debt] for some time, and we have replaced these with BBB,” Mr Sparks said.
“Investment grade only has a 50 per cent correlation with high yield, so where there’s a flight to quality. BBBs will go up in price whereas BBs will go down. That works well as a diversifier.”
A pick-up in merger and acquisitions (M&A) within the technology and telecoms, healthcare and energy sectors has seen more companies seek financing in the bond market, often at attractive yields.
BBB-rated firms involved in these deals have issued debt at higher-than-usual yields.
“There is a catalyst [for price increases],” the manager said.
“If a firm does a five- to 10-year new issue, we will buy the 10-year, BBB-rated debt. It will typically tighten 20 basis points in the first two to three weeks. They have to come cheap because there has to be a concession to get that much debt placed into the market.”
