Falling default rates, increased M&A activity and surging supply should drive a 7-8% return in the high yield corporate bond market in 2011, says Ian Edmonds, manager of the $1,897.08m* Legg Mason Western Asset Global Multi Strategy Bond Fund.
Edmonds, whose fund has returned 11.56% over the past year**, says that, while he has recently derisked the portfolio and taken some profits in high yield after strong year-to-date performance, he believes the backdrop for the asset class remains supportive both in the near and medium term.
“The default rate remains low and merger and acquisition activity is accelerating, which should benefit high-yield bondholders as investment-grade companies target high-yield corporations,” he says. “The other positive is that supply has surged this year. In the US market supply is running at an annualized basis of $365bn, far higher than the $262bn seen in 2010. The story is the same in Europe. Much of this issuance has been for refinancing, which is a positive for the market and allays fears about the rising number of maturities coming up in the high yield and loan markets in the coming years.”
A key threat to this outcome for the high yield market, says Edmonds, is if the global economy slows and credit quality deteriorates before the sharp increase in maturities in 2013 and 2014. “That would be a big risk and it is something we are keeping a close eye on,” he says. In the immediate term, Edmonds remains selective in the fund’s high yield exposure, focusing on utilities and other defensive sectors.
Across the portfolio, Edmonds has trimmed its allocation to investment grade bonds, where the Western credit team does not see enough value, and emerging markets, where the threat of further volatility has led to a reduction of some of the fund’s dollar-denominated sovereign and corporate debt. “We have been gradually rotating into local currency emerging market debt where we are seeing a combination of higher interest rates, as central banks begin to tighten, and gradual currency strength.” Edmonds has also reduced duration by half a year to four years.
“This has resulted in us building up some cash, although this is purely opportunistic and tactical to leave us in a position to take advantage of any market volatility in the future,” he says.
The key risk for the fund, says Edmonds, is that growth does not meet expectations or that global economies fall back into recession, although this is not the team’s base case scenario. The other big risk, in his view, comes from peripheral Europe where he expects continued volatility.
The fund was launched in August 2002, its objective is to maximise total returns through income and capital appreciation by diversifying across a range of fixed income securities and currencies.
