Investec Asset Management will reduce exposure to high-yield and emerging market bonds in its Global High Income Bond Fund if volatility increases as the Federal Reserve raises interest rates. "We could reduce our investment in higher-yielding assets to as low as 20% from 50% if we saw a repeat of 1994," said John Stopford, head of fixed income and manager of the $110 million fund. That was the last time rapidly rising interest rates brought an end to a long period of accommodative monetary policy. "We would get rid of the riskier stuff [such as] the triple-C high-yield names and some of our emerging markets exposure," he added.
Stopford expects the Fed Funds rate to rise by 1/4 point in June and to reach 2 1/4% by the end of the year. Mitigating his concerns is the fact that there has already been some 'pre-emptive unwinding' of riskier positions by competitors in anticipation of rising rates, and therefore he does not think a sell-off of the same magnitude as 1994 is likely.
The bias of the fund is towards being fully invested in high-yielding assets, with the balance in investment grade corporates. Over the past few months Stopford has cut the firm's combined high-yield corporate and emerging market debt exposure back from 90% to 50%--and the investment grade bond weighting up to 50%--by moving up the credit curve in high-yield and out of high volatility regions in emerging markets. "In emerging markets in particular, investors are not being paid to take on risk," he noted.
Stopford favors oil producing emerging markets including Russia, Mexico and Qatar, based on the high oil price, and has cut South American exposure altogether.
The firm also holds close to 30% in single-B names on the high-yield side, and another 25-30% in single-A names on the investment grade side. On an industry sector basis, these weightings are concentrated in industrials and both cyclical and non-cyclical consumer names. The fund refers to three different benchmarks: the Merrill Lynch European High-Yield Index, Merrill Lynch European Broad Market Index and J.P. Morgan Emerging Markets Bond Index.