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Scanning the Sterling High Yield sector

We look through the wreckage in this hard-hit segment of the bond market.

Christopher J. Traulsen, CFA 29 January, 2009 | 10:44AM
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The IMA's £ High Yield Sector was belatedly created only this past September--but one can easily see why it's about time the IMA caught up to other organisations and quit lumping these funds into "Other Bond". (We've had our own Sterling High Yield Morningstar Category for several years now.) Put simply, credit quality is one of the most significant axes of risk there is in the bond world (duration/interest-rate risk, currency exposure, and sector risk would be the others).

That significance was on rampant display in 2008, as credit risk sent the 20 funds in the £ High Yield sector to an average loss of 24%, roughly in line with the 23% loss of the ML GBP High Yield Index. At no time in recent memory has the distinction between higher and lower quality credits been as important as it w

as last year. After years of easy credit when risk was woefully underpriced by historic norms, markets reversed course and then some. Government funds uniformly outperformed corporate funds, which in turn uniformly outperformed high-yield funds, which were at the bottom of the heap.

In this market, we'd urge investors to be careful of sector rankings. The funds at the top of the IMA sector in 2008, for example, included some atypical offerings: Cazenove Strategic Bond, for example, is a go anywhere bond fund that can invest heavily in high-yield. Aviva Preference Shares, as its name suggests, invests in preference shares, not bonds. One fund that manifestly is a high-yield offering, and which we believe holds appeal within the sector, is Jim Leaviss's M&G High Yield Corporate Bond. Leaviss puts an emphasis on proprietary credit research, which we view as a must have for long-term success, and the fund's risk profile is on the moderate side for the IMA sector. The fund held up well in 2008, but it's worth noting that currency exposure may be partly responsible--the fund held a fair amount of Euro denominated issues, which would have helped it considerably.

Marlborough High Yield Fixed Interest was the worst performer in the category over the period: The fund, run by Aberdeen's Paul Reed, lost 43%, compared to a 37% loss for New Star Extra High Yield Bond, the next worst performer. Whilst the loss is eye-popping, there is something else about the fund that is symptomatic of a wider problem in the industry--the level of communication in its written public documents. These documents are important, because they are often the primary, if not the only, means by which those considering buying a fund or even those who already own a fund can learn about its activities. In this case, the fund's most recent monthly management commentary is a bare bones recitation of broad bond market activity, and its fact sheet gives no information on what went wrong in the year or management's current strategy (just the investment objective is stated), no credit quality breakdown, and no indication of currency exposures. In fact, the only portfolio data it has are the top-10 holdings and a maturity breakdown. The problem isn't unique to Marlborough, although its information is thinner than some other shops, but investors and advisors should demand better of the fund industry as a whole.

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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About Author

Christopher J. Traulsen, CFA  is director of fund research, Europe and Asia, Morningstar.