Fund in Focus - Schroders
An interview with: Julie Mandell
Who is Julie Mandell and what is your role?
My name is Julie Mandell and I am an Investment Director at Schroders. I have been with the firm for nearly 5 years and I represent the firm's global credit capabilities, which means I focus the majority of my time on business development opportunities. In this role, I work closely with the credit portfolio management team in order to understand the fund's current strategy, positioning and outlook so that they can convey the team's views when I meet with clients and prospects.
What are Schroders ISF Global High Yield's investment objectives?
The Schroder ISF Global High Yield fund aims to provide income and capital growth by investing primarily in a portfolio of bonds and other fixed and floating rate securities denominated in various currencies and issued primarily by corporate issuers worldwide. In order to achieve this objective, a minimum of 70% of the net assets of the Fund must be invested in securities with a credit rating below investment grade at all times. In addition, the fund may invest up to 30% combined in cash and/or bonds issued by governments, government agencies, or corporations rated investment grade.
Why should investors consider a High Yield Bonds in their portfolio?
Well that is certainly a good question especially given the volatility the sector experience in the 4th quarter. We believe that global high yield bonds should be a strategic component of a diversified investment portfolio. In our view, high yield bonds offer compelling characteristics that are likely to benefit a variety of investors.
First of all, high yield bonds have historically produced attractive returns with lower volatility than other major asset classes, such as equities. This is due in part to the fact that bondholders are higher in the capital structure than shareholders and therefore have better recovery rates in the event of a bankruptcy.
In addition, high yield bonds provide a higher coupon income than the dividend yield paid by the typical stock, which helps to reduce volatility and cushion returns during market downdrafts. As a result, we believe that global high yield bonds (GHY) can be an equity substitute for investors who are looking for attractive returns with less volatility than equities.
Secondly, high yield bongs have a low correlation to other fixed income sectors which makes them am important part of a diversified portfolio. The correlation of US HY to IG credit, EM and equities over the last 30 years has been moderate while the correlation to government bond is practically 0. This is critical as it shows how HY can be a great diversifies, especially during periods when rates are rising.
Finally, and building on the low correlation of HY to government bonds, the high yield sector is likely to perform better than other fixed income alternatives in a rising- rate environment for three main reasons.
- High yield bonds, generally, have a shorter duration than other fixed income sectors
- Higher coupon income tends to help offset price erosion when interest rates rise, relative to high-quality bonds
- Periods of riding rates tend to correspond with an improving economic environment, rising corporate profits and stronger fundamentals, all of which lead to lover default rate expectations.
History shows that high yield bonds have performed well not only during periods of rising Treasury rates, but also when the Federal Reserve is tightening, as these episodes do not always overlap. For these reasons, we believe that high yield bonds should be a strategic part of any investor's asset allocation.
What makes the Schroder ISF Global High Yield different?
This is a great question, as there are many managers in the universe and it can be hard to distinguish one from the next. The Schroder GYH fund differs from many other offerings in the market in a number of ways.
First, we are primarily a pure play developed market HY corporate bond fund. While many of our peers will have a large allocation to emerging market debt or even securitized bonds, we focus most of our attention on developed market corporate.
Second, unlike some of our peers, we invest across the credit spectrum as we don't want to limit ourselves when we identify opportunities. If we believe we are adequately compensated for taking on additional credit risk, we will invest in the lowest-rated HY bonds while some of our peers avoid these altogether.
Third, we believe that our smaller size, when compared to other managers, works to our advantage as we are not forced to invest in only the largest issues or through the new issue market, we can be more selective. We believe we have the best of both worlds as we have the breadth and depth of resources of a large firm which allows us to research many of the smaller mid-sized companies in the marketplace, while our mid-sized assets them allow us to invest in many of these smaller companies which are too small to make a difference to the largest asses manager.
While we are allowed to invest in sectors outside of HY corporates by prospectus, we typically do so in an effort to dampen volatility and not to amplify it. As it relates to this, we have a number of tools that help us navigate different mark environments. If we do want to reduce the overall level of risk in the fund, we can invest up 30% in government and IG bonds. Likewise, if we believe valuations warrent addtional risk, we can invest up to 20% in EMD. However, over the last 5 years, our average exposure to EMD has been 5%, so not a large allocation but it is another tool we can use if we believe the opportunity is attractive.
Finally, we believe that this flexibility to invest in other sectors, such as government bongs or IG corporates, allows us to better navigate up and down markets. This has resulted in a very strong upside and downside capture numbers. That is, when we don't believe we are being paid to take risk in HY, we can reduce our exposure there in favour of cash or IG corporate bonds which are only moderately correlated to HY bonds. Finally, we have the ability to use derivatives for both hedging purposes as well as to gain or reduce active exposures to credit and interest rates. This can be very useful when markets are moving quickly and its difficult to access cash bonds in the markets.
What is your outlook for the bond sector?
The outlook for credit is finely balanced. Healthy credit fundamentals across investment grade and high yield issuers coupled with a strong macro backdrop in the US are offset by declining demand and sentiment as rates rise and the end of the credit cycle approaches. After nearly a decade of expansion, September marked the first time since the crisis that central bank balance sheets contracted. We see this continuing with the European Central Bank (ECB) concluding its corporate bond-buying program at the end of 2018 and other central banks beginning to cut back asset purchases. We will monitor the impact on corporate bonds closely.
Valuations have become more attractive and fundamentals are reasonably healthy, but a period of transition looms for corporate bonds with central bank support being withdrawn and government bonds now offering more compelling investment alternative than they have in many years. Credit fundamentals are solid, but the outlook for demand and sentiment is uncertain. Tougher markets in 2018 have resulted in more attractive corporate bond valuations, while defaults and new supply are expected to remain low. The past year has been challenging for most areas of the credit markets as the transition from quantitative easing to quantitative tightening continues. This, among other things, has the potential to weigh on markets again in 2019 but we believe periods of volatility may present opportunities.
What do you feel the biggest risk in the market are currently?
Well this is always a great question to ask. As of now, our main area of concern as we enter 2019 is the tremendous growth we have witnessed in the leveraged loan market over the last few years and how this might impact the HY bond market. As you are probably aware, leveraged loans have received substantial demand from yield-seeking investors. In particular, as they are floating-rate securities, leveraged loans offer price protection against future increases in interest rates. Demand for floating- rate loans has been strong domestically and internationally, as well as form collateralise loan obligation (CLO) managers. This excessive demand for loans led to looser underwriting standards and gave weak companies access to capital markets and as a result, the risk profile of leveraged loans is higher than that of the high yield market. However, with a more dovish tone from the Federal Reserve Chairman, and with market consensus suggesting that there are possibly only two interest rate hikes remaining, it seems demand for rising rate protection is poised to decline. This will have an impact on loan prices that may have been unanticipated by investors. We are closely monitoring this segment of the market but at this point, do not anticipate any short-term impacts.
It is important that no actions should be taken without first taking advice. Personal circumstances and an individual’s appetite for risk means that the advice for one person may not be the same for everyone. Please remember that the value of your investment can go down as well as up, and may be worth less than you paid in. Information is based on our understanding at 9.01.2019.