MARCH 2024
Helping us deliver on our inflation-linked objectives: Barings Global High Yield
Bond investing is inherently a negative art. The very best managers in our view, are those that can avoid bad investments, as opposed to finding securities with the most upside. This is in part due to the nature of these assets, which have a pre-determined maturity value (therefore the mostly likely maximum return achievable is known with some accuracy at the outset), with the downside a total loss of one’s initial investment. As a comparison, equity investors aim to participate in the growth of businesses, which may result in a return 10 or even 100 times the initial investment. Of course, shares can also go to zero, but the risk versus potential return trade-off is clearly different for bond and equity investors.
When looking for a good bond manager, we place great importance on the ability to avoid the losers. The team at Barings are clearly skilled in this art. The Barings Global High Yield Bond fund falls into our Specialist Fixed bucket, therefore is return seeking (not a defensive fixed income allocation). It has a relatively straightforward mandate; to be fully invested in Global High Yield Bonds, which are also often referred to as junk bonds, or sub-investment grade bonds.
As the names suggest, the fund invests in the riskier part of the corporate bond market, in bonds issued by companies, that may not have the strongest balance sheets, or that have a more uncertain growth outlook. As investors we are compensated for the acceptance of this additional risk through higher coupons (i.e. higher potential returns). The value add that Barings bring to client portfolios is the credit analysis they perform on these corporate issuers, and the portfolio management expertise to create diversified exposure.
A very well-resourced High Yield team sits within the broader Barings public fixed income team of more than 120 analysts, traders, and portfolio managers, who comb through the financial statements of these businesses to independently verify their ability to make coupon payments, and ultimately repay the principal value of a bond. To some this highly intensive, almost forensic analysis of a company’s financial position may not seem interesting. However this, in our view, is a major source of Barings’ competitive advantage. It is this deeper understanding of the underlying businesses that allows the team to avoid those bonds that ultimately default (i.e. miss an interest payment or fail to repay principal).
| Average Annual Defaults & Implied Credit Losses: 2013 to 2021 | |||
|---|---|---|---|
| Barings | US High Yield | European High Yield | |
| Average Annual Defaults | 0.6% | 2.4% | 1.1% |
| Estimated Credit Losses | -0.3% | -1.4% | -0.6% |
| Estimated Additional Return per year, verus a 50% US / 50% European High Yield Benchmark: +0.7% p.a. | |||
While lower credit losses stack the odds of outperforming in the manager’s favour, this is not the only means of adding value in the high yield market, such as having exposure to those high yield bonds that are upgraded to investment grade status (so called rising stars) which is often accompanied by increasing bond prices. Additionally, the team dynamically manage both geographic and sector exposure, as well as the interest rate sensitivity of the portfolio through the cycle.
Perhaps a less obvious means of outperforming a passive alternative is managing fees and trading costs, which in High Yield is a very import consideration. Research from Insight Asset Management estimates transaction costs of running a portfolio that simply tracks the high yield index can cost up to 0.70% per year. In comparison, the Barings fund had an all-in cost of 0.83% in 2023, implying the net effective cost for the work of 70 credit analysts, and 3 very experienced portfolio managers is minimal. The combination of these positive characteristics is what have driven both strong absolute and relative performance from Barings versus peers, and the passive alternative over the longer term:
The above characteristics along with many others are what help us determine the most appropriate manager to utilise when accessing the High Yield bond market. While the manager selection decision is tangentially linked to the asset allocation decision to invest in High Yield bonds, the two are mutually exclusive. We base our decision to allocate to this asset class on the relative value versus other asset classes, and we then chose an underlying manager we believe will maximise risk-adjusted performance.
History has shown that, over the long-term, Global High Yield bonds have contributed positively to the risk-adjusted performance of multi asset portfolios. Only US Equities have outperformed Global High Yield Bonds since 1999. More importantly, the current yield on the asset class suggests that it will continue to assist us in delivering on our inflation linked investment objectives going forward, especially if Barings can continue to avoid the losers, allowing the winners to take care of themselves.
This commentary was prepared by Dean Barnard.
Dean is a Senior Investment Analyst, performing quantitative and qualitative analysis to identify attractive opportunities to include in MPS and bespoke portfolios. He finds navigating challenging markets intellectually rewarding, and enjoys the responsibility of being a steward of clients’ capital. Dean has over 10 years’ industry experience, including most recently as a Partner and Portfolio Manager at Core Wealth Managers. He is a CFA Charterholder and holds both the CFA UK Investment Management Certificate and the CFA Certificate in ESG Investing. In his spare time, Dean enjoys spending time outdoors with his wife and daughter, playing golf and wine tasting.