High Yield Bonds Unaffected by Rate Rise, say Schroders

High-yield bonds have very little sensitivity to interest rates compared to corporate bonds, says Schroders Mike Scott. They have much more sensitivity to the economic cycle

Emma Wall 15 December, 2015 | 2:39PM
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Emma Wall: Hello and welcome to the Morningstar series "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Mike Scott, Manager of the Schroder Monthly High Income Fund.

Hi, Mike.

Michael Scott: Hi, Emma. How are you?

Wall: I'm good. Thank you. So, we've reached December 2015 and we always like to take this opportunity to reflect on the 12 months that have been, this time of the year. I know you started 2015 by saying you thought the best opportunities would be within Europe and in particular, the U.K. Have you been proved right?

Scott: I think we have actually been proved right in terms of the Schroder's view on where the best places would be to invest within sort of the high-yield markets. I think this is really driven by the currency call. I think the sterling and European markets have certainly outperformed the U.S. I think that's also to do with the makeup of the market. I think the U.S. has certainly struggled given sort of the large weighting, say, to energy and metals and mining.

And in particular, we focused on financials and consumer cyclicals. I think as we've seen the oil price fall by more than 50% we've seen unemployment come down, we've seen real wages grow and I think that's really been reflected in sort of rising retail volumes.

So, one of our big calls this year was a very positive view on the consumer cyclical sectors, in particular retail, across the Euro area and this has been proved to be a very successful call within the fund.

Wall: To put it simply, people have had more money in their pocket and they have chosen to spend it?

Scott: Absolutely. They felt more confident about the outlook because the economy has been growing, unemployment has been coming down, jobs have been on the increase and real wages have been rising. In the U.K., for instance, that's been the first time in five years. So, this was very poignant moment I guess within the sort of consumer cycle and this has certainly played out as one of the major themes within the fund.

Wall: So, that's 2015. Looking forward in 2016, do you expect these themes to continue to run or where are you looking for the best investment opportunities now?

Scott: I think we still have quite a positive view on financials. I think the financials backdrop is still quite a positive one for a creditor. That's both driven by sort of regulatory and institutional reforms. So, banks are being forced to raise more and more equity to be held against the assets which they then on-lend to the economy and this is only a good thing for bond holders. We're not in the regimes where we were before pre-crisis where banks held very, very little equity.

Regulators have been very keen for banks to raise more capital and raise more equity to hold against the loans they then issue to the real economy. And this from a creditor's point of view is a very attractive proposition. We think that this growth in sort of equity base or improving credit quality is a multi-year trend and this also drive improved valuations or support valuations within the financial sector.

Wall: Looking at 2016 though, I'm sure you're bored of it, I'm bored of it, the readers are bored of it, but we have to talk about interest rates because they are probably going to come up within the next six months. How does that affect where you're investing or really is everything priced in now, it's not going to be a shock?

Scott: That's a very good question. I guess from the points of high yield and the very important distinction to make with high-yield bonds relative to, say, investment-grade or high-quality or government bonds is that they have relatively little sensitivities to interest rates.

They have much more sensitivity to the economic cycle. So, in many ways, whilst interest rates are likely to go up tomorrow by the Fed and potentially a key to I would imagine on sort of current trends in the U.K., this will have little impact on the high-yield market.

Where it will come into play I guess will be those sectors where interest rates or the cost of borrowing may have an impact on say consumer spending. So, I guess looking into next year, I might have a less positive view on consumer spending, say, in the U.K. post to first rate rise.

But I still think that whilst the U.K. consumer has deleveraged to a certain degree, we are still quite a leveraged economy. A lot of our outgoings are still being used to pay mortgages and pay credits cards.

And I think that as interest rates rise and depending on how far they do rise that is obviously a headwind I guess looking into next year. I'm not saying that this is the end of the consumer cycle but I just don't think we're going to have as positive a year as we had this year.

Wall: Mike, thank you very much.

Scott: Not at all.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Schroder High Yield Opportunities Acc1.50 GBP-0.66Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar