High-yield fixed income remains on the plates of institutional asset owners despite the recent shuttering of two high-yield mutual funds that capped a difficult year for the asset class.
In fact, some think this might be the time to feast on high yield.
“The opportunity is great given the mess caused by retail investors,” said David Holmgren, chief investment officer, Hartford HealthCare, Hartford, Conn., with $3 billion in pension and other assets. “Those investors were looking for return that they couldn't get in their (certificates of deposit) or bank accounts. They went after too much yield. But for us, we've got more opportunity now in high yield as a result of what's gone on of late.”
Added David Long, senior vice president and chief investment officer, asset-liability modeling and derivatives and fixed income, at the C$60.8 billion ($44.2 billion) Healthcare of Ontario Pension Plan, Toronto: “As a long-term investor, any time assets fall off so markedly, you take a second look. High yield has been underperforming. You could argue that the risk premium has gone up in the sell-off. But if you're more of a trader, then it looks like a bear market, doesn't it? It's a better time to buy than a month ago or a year ago. This might mean it's the right time to buy.”
As is, 2015 — and particularly the first two weeks of December — won't be remembered as boom time for high-yield debt in terms of returns. The Barclays Capital U.S. Corporate High Yield index was -5.05% year-to-date Dec. 15 and -3.1% for the first 11 trading days of December. In contrast, the Barclays Capital U.S. Aggregate Bond index is up 0.52% year-to-date and down 0.35% for the month, both through Dec. 15.
Heightening concern over high-yield returns were the closings Dec. 9 of the $788.5 million Third Avenue Focused Credit Fund and the $400 million credit hedge fund managed by Stone Lion Capital Partners, respectively, along with the Dec. 14 liquidation of Lucidus Capital Partners, a $900 million high-yield credit fund.
But, sources said, those funds were in riskier energy-related investments than most other high-yield funds — particularly those used by pension funds, endowments and foundations. And while some investment executives at those types of institutions might still be concerned, the reasons they invest in high yield — as a diversifier in their fixed-income portfolio, with some correlation to equities — haven't changed.
“We haven't seen a lot of money moving into high yield, but there's not a lot of shifting out of high yield,” said Dan Lomelino, senior investment consultant and head of fixed-income manager research at Towers Watson & Co., Chicago. “People still believe in the benefits of high yield although there has been a rough period. A few clients have touched base about it, but generally, (the concentration of fund closings) is a case of a manager that shouldn't have been holding such risky investments.”
Jas Thandi, associate partner, global asset allocation, Aon Hewitt Investment Consulting Inc., Chicago, suggested high-yield debt allocations for institutional asset owners should range from 5% to 10% of overall assets, and not higher than 15%. “For asset owners that already have a high-yield allocation, selling now probably (is) not the best thing to do, but we expect there will be some continued deterioration before things turn around,” Mr. Thandi said. “I'd expect asset owners to be looking at active high-yield management. Right now, we're seeing spreads close to 700 basis points. In the 2010 euro crisis, spreads were 900 basis points. We're not quite where the entire market is distressed. The time to sell was when spreads were 400 basis points and high-yield bonds were overvalued.”
Mr. Long of HOOPP said that what's been happening of late with high yield “makes us view it as a better long-term investment. It's cheaper. I view the space more positively than a while ago.”
However, executives at HOOPP, which invests in high-yield fixed-income strategies as well as accessing itthrough credit-default swaps and loans, haven't decided yet whether to add to the asset class. “I don't know if it would trigger an investment change with us just yet,” he said. “We look at it on more of a forward-looking basis, not a backward-looking basis. Looking at past performance is not always good, especially in credit.” Mr. Long would not say how much HOOPP has invested in high yield.
The rush of retail investors earlier this year into high yield has been a concern to institutionalasset owners, said Scott C. Malpass, vice president and chief investment officer of the $10.5 billion University of Notre Dame endowment, South Bend, Ind.
“One significant concern surrounds market structure and liquidity,” Mr. Malpass said. “As banks and brokers have stepped back, retail investors have become a larger portion of the investor base, and markets are not made as easily. Flows are more volatile, and trade-lot sizes are getting smaller. In addition, there are fewer bids in the market, and less inventory with which to make markets. This results in a more volatile price environment and a less-liquid exchange.”
Mr. Malpass said he's heard of concerns among institutional investors “about the ability of daily liquidity vehicles to liquidate their positions to meet redemptions. In our understanding, Third Avenue's fund was a small example of this phenomenon when they prevented investors from withdrawing capital from their high-yield fund.”
Notre Dame's endowment does not invest in long-term high-yield debt, Mr. Malpass said, instead focusing more on distressed debt. “Both have equity-like risk, but you get paid more for it in distressed,” he said.
Mr. Holmgren of Hartford HealthCare echoed Mr. Malpass' views on the impact of retail investors in high yield.
“There's a huge difference between retail and institutional investing,” Mr. Holmgren said. “If anything, the current mess around high-yield liquidity actually drives that distinction even greater. Individuals, for obvious reasons in this low-rate environment, have been chasing yield and recently taken positions in product offerings that they think hold potential of better returns.”
Pension fund and endowment investors “are far more strategic and more liquidity-aware than retail,” Mr. Holmgren added. “For ourselves at HHC, like other institutional investors, high yield is an opportunistic allocation and although we have no dedicated allocation to high yield, we certainly have managers which can seize this newly created opportunity.”
In February, Hartford HealthCare doubled its allocation to Shenkman Capital Management's high-yield fixed-income portfolio to $50 million from $25 million, and Mr. Holmgren said the current situation in the asset class is presenting more opportunities. High yield is part of HHC's 35% risk-reduction allocation, which includes a variety of fixed income and hedge funds; its remaining allocation is 55% growth, which includes private and public equities, and 10% on economically hedged assets, including real estate.
Gregory Moore, vice president, head of traditional investment managers at consultant Segal Rogerscasey, Norwalk, Conn., said his firm hasn't changed its long-term view of high yield debt as an asRogerscasey, Norwalk, Conn., said his firm hasn't changed its long-term view of high yield debt as an asset class.
“I think some asset owners might be exploring combinations of high-yield bonds and loans, looking at credit more broadly, being more flexible with below-investment-grade, more floating-rate fixed income, a more tactical allocation between bonds and loans,” Mr. Moore said. “But none of that is in reaction to the recent fund closings. It's a trend that's been going on recently.”