Threadneedle (Lux) US$ High Income Bonds Fund

Transcription

1 Threadneedle (Lux) US$ High Income Bonds Fund Covering Q Threadneedle (Lux) US$ High Income Bonds Fund (sub-advised by Columbia Management) Brian J Lavin Fund Manager Columbia Management Fund performance High yield bonds continued to post positive returns in March despite the European crisis taking centre stage once again. During the first quarter of the year, the Threadneedle (Lux) US$ High Income Bonds Fund returned 1.94% on a net basis*. High yield underperformed equities but outperformed other fixed income asset classes. The US 10- Year Treasury, the Barclays Aggregate Bond Index and the S&P 500 Index returned %, -0.12% and 10.61% respectively. Lower quality credit outperformed during the quarter. BB, B and CCC rated sectors returned 1.88%, 2.91% and 5.81% respectively. Broadly, high-yield spreads tightened 43 bps in the first quarter to finish at +480 bps. Spread changes by rating category BB, B and CCC were -18 bps, -44 bps and -103 bps respectively. Market review Improved US economic sentiment helped pave the way for a rally in risk assets during the deal on US income taxes to start the year. Looking to other markets, even the failure of Italian elections to form a government and the announcement and ongoing discussions around the unprecedented terms for the Cypriot bailout package had little effect on US risk assets in the quarter. Equities posted impressive gains, while high-yield bond returns were positive but modest compared to equities, as the high-yield asset class continues to be call-constrained and at all-time low yields. High-yield bond net flows were slightly positive for the quarter, but inconsistent and even posted five consecutive weeks of outflows mid-quarter. US economic data improved throughout the quarter, showing signs of improvement in initial unemployment claims and the housing sector. Consumers have thus far been resilient through the expiration of the payroll tax holiday and elevated gas prices appearing to be shrugging off the impacts of sequestration. Additionally, fourthquarter earnings were largely supportive, as S&P 500 Index earnings results came in ahead of expectations, with an average ex-financials earnings growth rate of 4.0% vs. expectations of 0.8% at year end. Companies took advantage of the low-rate environment and accessible markets, resulting in the strongest quarter of new issuance on record, using roughly 85% of the proceeds to refinance higher coupon debt and build cash to shore up balance sheets. Issued: / Valid to: / T13272 Page 1 of 5

2 High-yield fund flows were slightly positive for the quarter, posting a $0.8 billion inflow. New issuance set a quarterly record as 234 new deals were priced totalling $119 billion. There were seven defaults in the quarter totalling $2.3 billion. Investment outlook The primary thesis for the manager s outlook for high-yield remains unchanged. The fund manager remains positive on high yield given the solid fundamentals supporting the asset class. However, expectations for investment returns should be tempered due to current valuations. The manager expects returns in the mid-single-digit range for 2013, incorporating the potential for rising longer term yields and limited price appreciation, given the high percentage of the market already trading above the first call. Corporate fundamentals remain strong. Access to capital has been at record levels, allowing companies to refinance debt. The benefit of refinancing will continue to assist companies for years to come, as they have locked in debt at very low rates and reduced near-term maturities. In addition, the macro uncertainty has kept most management teams conservative and focused on deleveraging. However, leverage has ticked up and the focus is primarily on returning value to shareholders through acquisition-supported growth, dividends and share repurchases. Further deleveraging should not be expected at this point in the credit cycle, but the manager does not believe that a return to significant releveraging is likely either. There are still too many uncertainties remaining and a still uneven economy, which should keep companies more balanced. Of course there are always exceptions, and there is evidence of more aggressive behaviour. Up until now, the quality of high-yield issuance has not deteriorated meaningfully. That being said, conversations with investment bankers suggest that there may be more aggressive terms, pricing and issuance in the year ahead. The bankers are on the leading edge of deals and see aggressive terms offered to companies/sponsors in order to win their business. This is typical competitive dealer behaviour when market risks have declined, but it is the investor who ultimately loses value from pricing and structure. A few examples of weaker terms include investment-grade-like covenants, shorter call periods and weak change of control provisions. The good news is that investors are still being selective, as challenging deals have to be restructured or pulled from the market. The overwhelming demand for the new acquisition finance debt for HJ Heinz highlights the appetite investors have for quality companies with strong sponsor/management reputations. A number of high-yield issuers have been able to tap the equity market through initial public offerings or secondary equity offerings, adding to investor confidence as well as expanding equity multiples in many industries, which has added to equity value support beneath the bonds. Issued: / Valid to: / T13272 Page 2 of 5

3 Earnings growth has been decelerating and is expected to be weak in the first quarter of 2013, but remains positive overall. Consensus 2013 expectations call for S&P 500 Index revenue growth of 3.1% and earnings growth of 6.7%. Earnings growth is back-end loaded, however, quarterly expectations are for -1.9%, 6.2%, 8.4% and 5.1%, respectively for the first quarter through the fourth quarter. Management teams from consumeroriented businesses remain cautious in their outlooks due to soft spending levels despite improvement in demand for larger ticket items such as housing and new car sales. Delayed timing of tax refunds and an unseasonably warm spring have clouded the data, making it difficult to discern what the impact has been from increased payroll taxes. Despite the considerable deleveraging made by corporations and consumers, there is significant work ahead to reduce government deficits. Virtually all the same macro related risks remain, as Italian elections and the Cyprus banking situation served to remind investors, but have been taken in stride due to confidence stemming from central bank activity. The continued overhang of high unemployment, uneven US economic activity and high government deficits are expected to keep growth muted and vulnerable to external shocks. Consensus expectations are calling for a 1.90% gross domestic product growth rate for the US in 2013, which has increased from expectations of 1.80%, as better-thanexpected first quarter economic data has led economists to increase their growth expectations for the year. However, significant uncertainty remains around the impact from sequestration. Economists and companies are likely to wait this out to see what happens before becoming too optimistic. Signs of stability and improvement have been highlighted in China s recent economic numbers and the US labour markets. Housing markets are also showing signs of improvement. With a solid fundamental backdrop to high yield and the potential for the U.S. economy and labour market to show signs of improvement in 2013, this could result in a rise in interest rates, which is likely to mute the returns of the asset class. We believe the sensitivity to rates has the potential to increase in this cycle relative to previous cycles given the low absolute level of interest rates. However, it is important to keep in mind that an improving economy is highly supportive of credit fundamentals and should allow for spreads to compress under this scenario. There has been a lot of activity from Federal Reserve members discussing the cost/benefit of quantitative easing and the potential exit path. It is important to note that the discussion now centres on the timing of the exit and not on adding another dose of quantitative easing. This is a very different place from a year ago, let alone four months ago. This, combined with the improvement in US economic data, has us clearly focused on the potential for a rise in interest rates over the next 12 months. Issued: / Valid to: / T13272 Page 3 of 5

4 Investors continue to look for yield and the high-yield asset class continues to be supported by the solid fundamental backdrop. It remains an attractive investment alternative to other core fixed-income products that may have greater interest-rate volatility and offer lower yields. As a result, retail and institutional demand is expected to continue to be solid in On the margin, there may be some shifts out of the asset class into equities for investors seeking additional risk and return and into leveraged loans as investors look to protect against interest-rate risk. Retail loan demand has outpaced retail high-yield bond funds by 19 to 1, as loans have posted $15.3 billion into funds year to date vs. $0.8 billion in high-yield bond funds. In addition, $27.9 billion of collateralised loan obligations has been launched, adding to loan demand. Supply should continue to meet demand in the marketplace, as we expect additional refinancing and a likely uptick in acquisition, dividend and leveraged buyout financings this year. Dealers remain optimistic about supply created by mergers and acquisitions (M&A). Although North American M&A volumes increased 41% year over year in the first quarter, M&A activity has been slower than expected. However, loan demand and attractive valuations and terms are likely to shift issuance to loans when possible. Loans provide companies with more flexibility with less prepayment penalties than bonds. The manager had been looking for a potential increase in European financings given attractive valuations, but has been guided to expect levels not to increase, as banks have become more comfortable with their lending portfolios. Valuations are less attractive than they were a year ago, but the tail risks are more muted too. Yields of 5.65% yield to worst are at all-time lows given the low absolute level of interest rates. High yield is now pricing in a 3.2% default rate vs. 7.0% at the beginning of last year. The manager s internal expectations for defaults are that default rates will remain below 2% in 2013 and As a result, there is adequate compensation for credit and default risks, but less compensation for broader macro-related risks. In addition, the market overall has less upside potential, with 47% of high-yield bonds trading above the next call price. This leaves less room for price appreciation and causes more reliance on coupon income to generate returns. Given the stable fundamentals of the high-yield asset class with below-average defaultrate expectations, limited refinancing risk, low overall levels of leverage and reasonable earnings outlook, we still view high yield as an attractive investment alternative to other core fixed-income products. Although constructive on credit fundamentals, the fund manager does not believe that this is the time to stretch for return or reach for yield by adding significant risk to the portfolio. Valuations have compressed, and there is limited room for price appreciation. He believes that credit selection will continue to be a key driver of our performance over the coming Issued: / Valid to: / T13272 Page 4 of 5

5 year, and by positioning for improving credit situations, avoiding credits with deteriorating fundamentals and remaining disciplined in terms of getting paid for taking risk, the fund will generate solid risk-adjusted returns. He will continue to maintain a disciplined credit selection based on strong fundamental analysis and rigorous risk management in order to take advantage of opportunities in the marketplace. The views expressed in this report are those of Columbia Management who are the sub-advisor for the Threadneedle (Lux) US$ High Income Bonds. * Source: Morningstar as at fund performance shown for AU share class, net of fees with any income reinvested, performance is calculated in USD. Important Information Singapore The research and analysis included in this document have not been prepared in accordance with the legal requirements designed to promote its independence and have been produced by Threadneedle for its own management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. This document may not be reproduced in any form or passed on to any third party without the express written permission of Threadneedle. This document is the property of Threadneedle and must be returned upon request. A Singapore prospectus ( Prospectus ) can be obtained free of charge from any of our authorized distributors or downloaded from Investors should read the Prospectus for further details before deciding whether to subscribe for or purchase shares. The Fund may invest in financial derivative instruments to the extent permitted under relevant laws. Past performance of the Fund and its Manager and any forecasts or information on the economic trends are not necessarily indicative of the future or likely performance of the Fund or its Manager or a guarantee of future trends. The information provided in this document is for informational purpose only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments, or to provide investment advice or services. This publication does not have regard to the specific investment objective(s), financial situation or the particular needs of any person. Investors may wish to seek advice from financial adviser before making a commitment to invest. In the event an investor chooses not to seek advice from a financial adviser, the investor should consider whether the Fund is suitable for him. Threadneedle (Lux) is an investment company with variable capital (Société d investissement à capital variable, or SICAV ) formed under the laws of the Grand Duchy of Luxembourg. The SICAV issues, redeems and exchanges shares of different classes, which are listed on the Luxembourg Stock Exchange. Threadneedle Management Luxembourg S.A. is advised by Threadneedle Asset Management Ltd. and/or selected sub-advisors. Threadneedle Management Luxembourg S.A. has appointed State Street Bank and Trust Company Singapore Branch as its Singapore representative. Issued in Singapore by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore Regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). License number: CMS This document is not a prospectus as defined in the SFA. Accordingly, statutory liability under the SFA in relation to the content of prospectuses would not apply. Threadneedle Investments is a brand name and both the Threadneedle Investments name and logo are trademarks or registered trademarks of the Threadneedle group of companies. threadneedle.com Issued: / Valid to: / T13272 Page 5 of 5