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|Case study: investing in Robeco High Yield
High-yield bonds offer investors attractive credit spreads: the current US high yield credit spread is 480 bp on government bonds. Figure 2 shows the US high yield credit spread since 1994. But what is the best way to reap the benefits of this credit spread, when long-term interest rates can have a major impact on total returns?
Robeco High Yield Zero Duration offers protection against a further rise in long-term interest rates by exchanging the 5-year swap rate for the 3-months swap rate.
The cumulative performance difference (in %) between the zero and regular high-yield share class is shown in Figure 3 (red line) together with the development of the 5-year swap rate (blue line). They can be seen to have moved more or less in line. The performance of the Robeco High Yield Zero-duration share class versus the regular class can also be seen in Figure 3. The Zero-duration class outperformed the regular share class in recent weeks as a result of increasing interest rates.
The return on a high yield bond corresponds to a yield on a comparable government bond plus a credit spread (higher interest rate) to compensate for the risk associated with a high-yield investment.
The regular Robeco High Yield share class offers a yield of 6.4%, consisting of a long-term interest rate of 1.7% and a credit spread of 4.7%. The sensitivity of the interest rate and of the credit spread is 4-5 years.
The Robeco Zero-Duration share class offers a yield of 4.9%, consisting of a short-term interest rate of 0.2% and a credit spread that is also 4.7%. The sensitivity of the interest rate component is reduced to around zero, while the sensitivity of the credit spread is around five years.
The Robeco High Yield fund manager expects returns in line with yields for the next twelve months of around 6.4% (as per end of June 2013. Following the recent yield increase, he has been adding slightly more risk to the portfolio by adding some bonds that repriced disproportionately. The credit beta of the fund has been increased from underweight to neutral (beta is 1). In the US, there have been outflows in high-yield ETF holdings, represented by predominantly tactical investors. This has been much less the case with actively managed funds like Robeco’s High Yield fund.
The fund manager believes that the search for yield is not over yet, and that investors might add risk to their portfolios once the markets stabilize somewhat. On the back of the relatively weak economy, it remains key to focus within the high-yield universe on the strongest companies able to weather the storm. Robeco High Yield therefore avoids the weakest issuers.