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Canadian fund managers see opportunity amid high-yield bond sell-off

The Bank of England is seen through columns in the City of London, in this file photo

Neil Hall/Reuters

The sell-off in U.S. high-yield bonds has some Canadian fund managers seeing a buying opportunity, rather than a reason to panic.

U.S. high yields are on course for the worst year since the financial crisis, which has forced three credit funds to wind down in recent days.

"We're still constructive on non-resource high yield," said Dhruv Mallick, a fixed income analyst at Leith Wheeler Investment Counsel in Vancouver. "You can find companies with good balance sheet positions, and strong free cash flow … at 7 or 8 per cent (yield)."

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The SPDR Barclays High Yield Bond ETF, which is considered one of the proxies for the performance of the high yield market, has declined by 13.4 per cent so far this year to its lowest level since 2009.

The liquidation of Lucidus Capital Partners and the shuttering of a Third Avenue Management fund have raised some fears about a potential spate of high yield fund failures, as predicted by the likes of billionaire investor Carl Icahn.

But Lucidas and Third Avenue dealt in riskier credits than what is typical of traditional high yield funds, Mr. Mallick said. Half of Third Avenue's portfolio, for example, was invested in unrated bonds, and most of the rest was rated at CCC or worse.

"That's a completely different kind of asset class," Mr. Mallick said. "That's more of a stressed or distressed debt fund."

The fear of contagion, however, could add fuel to the high-yield sell-off over the coming weeks, he added. "When an investor sees headlines saying high-yield funds are closing down, they could hit the sell button."

But aside from the selling pressure, the high-yield market does not seem to be under much strain fundamentally, outside of energy and mining, Mr. Mallick said.

Corporate balance sheets are in good shape, and default rates are expected to be fairly muted, despite the low-growth environment, said Robert Spector, a fixed income portfolio manager at MFS Investment Management.

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"I think it would take a much weaker earnings and cash flow environment to dent their prospects," he said.

Meanwhile, the downdraft over the second half of this year has widened high-yield credit spreads to attractive levels, Mr. Spector said.

"The value compensates even for a potential uptick in default rates, from our perspective."

The focus among Canadian high-yield investors is in the U.S., as the domestic market is small and shrinking, with a heavy concentration in the resource sector.

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About the Author
Investing reporter

Tim Shufelt joined the Globe and Mail in August, 2013, primarily to cover investments for Report on Business. Prior to the Globe, he worked as a staff writer at Canadian Business magazine, a business reporter at the Financial Post, and covered city news and courts for the Ottawa Citizen. More

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