Legal & General urges investors to look at high yield

Investors are increasingly looking for income-focused strategies that are less sensitive to interest rate and inflation shocks, with  high yield bonds.    

Investors should consider permanent allocations to high yield, rather than government, bonds, according to Legal & General high yield and credit specialists.

“Defaults have generally been avoided, interest rates have been kept ultra-low and investors have been forced into buying increasingly risky debt in order to maintain yield income,” Ben Bennett, head of credit strategy at Legal & General told Private Debt Investor at an L&G briefing. “But now investors are facing nascent economic recovery and an associated tightening of monetary policy.”

Given how far yields have fallen, interest rate hikes and quantitative easing reversal would be a potentially explosive combination for the (government) bond markets, he explained. “Those investors that sold bonds at the start of 2011 and 2012 hoping for a US economic rebound were ultimately left scrambling to buy back the debt at a lower yield.”

The (government) bond market is also being explicitly supported by central banks buying debt as part of quantitative easing, according to Bennett. “The US Federal Reserve has made it very clear that it will continue to buy debts until the labour market has improved substantially. Even those central banks that have paused their quantitative easing, such as the Bank of England, are unlikely to sell their bonds any time soon, and will keep interest rates low for fear of upsetting the housing market.”

Following the equities rally, any economic hiccup in the coming months could lead to another year of bond market outperformance as investors look for a safe place to hide. 

“Interest rates and bond yields are low, which means more investors are searching for sources of yield,” explained Martin Reeves, head of high yield at Legal & General.  According to Reeves, the global expansion of the market means investors can and should adopt a wider view to high yield investing – the opportunity set is widened as is the potential for enhanced risk-adjusted returns.

“Not only do high yield investors benefit from high levels of income but they can also find they are investing in robust, well-managed companies,” added Reeves.

Reeves warned however that the lower-rated CCC bonds account for a considerably higher number of overall defaults. “Fortunately, there is enough liquidity and diversity in the market to completely avoid exposure to CCC-rated bonds,” he said.