When it came to leading bond returns, high-yield managers were a dominant force since at least the first quarter of 2006; they were the fixed-income separate-account equivalent of pro football's New England Patriots.
But as the Patriots crumbled to their first loss of the season in the Super Bowl, high-yield bond managers succumbed to a flight to quality and investors' expectations of increasing defaults in 2008, sinking returns below those for government bond managers.
The result was a dramatic reversal in terms of leading strategies in the Morningstar Inc. Separate Account/Commingled Fund Database for the year ended Dec. 31, said Steve Deutsch, director of separate accounts and collective investment trusts for Morningstar in Chicago. "It doesn't look like any money managers on the high-yield side escaped the impact."
The median high-yield manager in the Morningstar database returned 3.37% at the end of the fourth quarter 2007, down from 8.05% for the year ended Sept. 30.
The Credit Suisse High Yield index returned 2.7% for the year ended Dec. 31, down from 8.4% for the year ended Sept. 30, while the Lehman Brothers U.S. Government/Credit Bond index returned 7.2% for the period, up from 5.1% for the year ended Sept. 30.
In a Feb. 7 report, Edward I. Altman, the Max L. Heine professor of finance at New York University's Stern School of Business, said: "A market that was incredibly liquid for almost the entire first half of the year reversed itself and became much less so with spreads more than doubling in the second half, as investors for the first time in five years required a greater-than-historical average yield-to-maturity spread by year end."
Investors in late 2007 were fearful of rising high-yield defaults, further fueling a flight to quality spurred by the subprime crisis, Mr. Altman said in a telephone interview.
Reams Asset Management, Columbus, Ind., was the top high-yield bond performer for 2007 with a return of 8.95%. But that trailed the overall U.S. bond strategies leader - PanAgora Asset Management Inc., Boston, which returned 16.14% for the year in its long/short strategy - by 719 basis points.
The remaining performers in the top 10 of the high-yield universe were: Prudential Retirement, Hartford, Conn., at 6.4%; Calamos Investments, Naperville, Ill., at 5.6%; AXA Investment Managers, Greenwich, Conn., at 5.1%; Capital Guardian Trust Co., Los Angeles, at 5%. Nuveen Asset Management and AmalgaTrust Co. Inc., both of Chicago, earned 4.72% and 4.70% respectively; Bradford & Marzec Inc., Los Angeles, 4.69%; KDP Asset Management Co., Montpelier, Vt., 4.68%; and Federated Investors Inc., Pittsburgh, 4.49%.
High-yield returns in 2008 won't likely return to their previous dominance, Mr. Altman said. High-yield defaults in January topped $4 billion, almost 73% of the $5.5 billion total for all of 2007, and Mr. Altman projected defaults to rise nine-fold from 0.5% last year to 4.6% in 2008.
However, high-yield's dominance remained evident in five-year returns, as high-yield managers claimed all 10 of the top overall spots. The top five managers were: DuPont Capital Management Corp., Wilmington, Del., at 18%; PENN Capital Management Co. Inc., Cherry Hill, N.J., 14.9%; SMH Capital Advisors Inc., Fort Worth, Texas, 14.4%; MFC Global Investment Management, Toronto, 14.4%; and DDJ Capital Management LLC, Waltham, Mass., 14.3%.