This document summarizes an interview with David Harris, a fixed income portfolio manager with Schroders, about the outlook for high yield bonds in 2009. Some key points: - High yield bonds currently offer yields around 12-13% due to high risk premiums, and are expected to outperform other asset classes in 2009 given their attractive yields. - Default risks are high currently with implied default rates around 13.7%, higher than past recessions, but active management can help mitigate these risks. - Volatility is expected to remain high throughout 2009 as the economic outlook remains uncertain, but total returns of 8-12% are forecast for high yield bonds in 2009.

1. investment insight
by St ephanie t h n g
Looking To
High Yield Bonds
In 2009
High yield bonds look set to be one of the outperforming
asset classes this year. DaviD Harris, Us Fixed income
Portfolio Manager with schroders, tells us more.
image source: stockxpert.com
W
orld growth is forecast a year-on-year basis (as at 28 Janu-
to fall to its lowest level ary 2009). With the volatility rag-
since World War II, ing in the equity markets, it is little
said the International Monetary wonder that the majority of inves-
Fund (IMF) in its latest World Eco- tors are shunning equities, flock-
nomic Outlook (28 January 2009). ing instead to safer havens such as
The IMF added that financial bonds and US Treasuries.
markets “remain under stress” and A safe haven it may be, but US
that “the global economy is taking Treasuries are hardly offering the
a sharp turn for the worse”. best value for investors currently.
In this economic climate, finan- At one point in time in December
cial markets have taken a severe last year, panic among investors
beating – global equity markets, drove the yield of 3-month US
as represented by the MSCI World Treasuries below zero, as investors
Index, have declined by 40.1% on flocked en masse to the safety of-
72 |
February ~ July 2009
Article disclAimer: This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund’s prospectus. Any advice herein is made on a general basis
and does not take into account the specific investment objectives of the specific person or group of persons. As some of the authors/contributors may have a personal interest in some of the funds commented on, investors should seek the advice of professional advisers regarding
the evaluation of any product, unit trust or other financial instruments, report, index, opinion or any other content contained herein, to ensure the investment instrument is suitable for them. In the event that investors choose not to seek advice from a professional adviser, they
should consider whether the investment instrument is suitable for them. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed
herein are subject to change without notice. iFAST Financial and/or its licensed financial advisers representatives may own or have positions in the funds of any of the asset management firms or fund houses mentioned or referred to in the article, or any unit trusts or Singapore
Government Securities bonds related thereto, and may from time to time add or dispose of, or may be materially interested in any such unit trusts or Singapore Government Securities bonds.

2. fered by US Treasuries, as a refuge investment-grade corporate bonds Based in New York, David
from the extreme volatility in the and high yield bonds, which offer joined Schroders in 1992, and has
equity markets. Pundits are pre- better value; but the risks involved more than 20 years of investment
dicting that a big bubble is form- are admittedly higher as well. In- experience. David holds an MBA
ing in US Treasuries, as yields vestors with a higher risk appetite from J.L. Kellogg Graduate School
have plunged to the lowest levels in could consider adding high yield of Management, Northwestern
decades. And if the pundits have it bonds into their portfolios. University, as well as a BBA from
right, this bubble looks set to pop High yield bonds, otherwise the University of Massachusetts at
anytime. known as non-investment grade Amherst.
David Harris, US Fixed Income bonds or junk bonds, refer to
iFAST: Based on the factsheet as at
Portfolio Manager with Schroders, bonds with a credit rating of “BB”
end-November 2008, the fund has
expects the yields on US Treas- and below (Standard and Poor’s) or
78.8% in the United States. What
uries to remain depressed for the “BB+” and below (Fitch Ratings).
are the reasons behind this?
whole of 2009. “US Treasuries are Unknown to many non-investors
expensive by nearly every measure, of global high yield bonds, the glo- David Harris (DH): The 78.8%
(and) are likely to remain expen- bal high yield bond space is largely figure represents the share of issu-
sive through the first half of 2009 dominated by issuers domiciled in ers domiciled or registered in the
and possibly through the end of North America. “There is common US, and compares to 81.1% in
the year. Persistent weak economic perception that the global distribu- the benchmark. The 2.3% under-
conditions, widespread investor tion of high yield issuers is similar weight in the US was offset with
risk avoidance and deflationary to that of government bonds or an overweight in Europe and Asia.
pressures will contribute to keep- investment-grade issues. High yield The substantial market disarray in
ing Treasury yields low.” is actually a relatively new fixed in- late 2008 impacted high yield mar-
But government actions and come sector outside of North Amer- kets in Europe and Asia dispro-
the risk of rising inflation should ica, and the US in fact remains the portionally, due to more concen-
lift the yields of the US Treasur- largest source of high yield issuers,” trated industry exposure and less
ies from the doldrums, in 2010 and commented David. deep investor demand. The fund
beyond. “Eventually, we do believe In an interview with David, he is positioned to take advantage of
that massive fiscal and monetary tells us more about the outlook for normalisation of spreads in these
stimulus will cause Treasury yields high yield bonds in 2009, and why markets.
to increase in order to compensate he expects this asset class to be one
iFAST: Against the backdrop of a global
for the risk of higher inflation in of the outperforming asset classes
recession, the default risks for high-yield
2010 and beyond,” adds David. this year. He also shares with us
bonds would conceivably go up. What
Apart from US Treasuries, the risks faced by investors of high
is being done to mitigate such risks?
money has also been flowing to yield bonds this year. ➝
73
Important: See Disclaimer on Page 6 iFAST INSIGHT |
Article disclAimer: This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund’s prospectus. Any advice herein is made on a general basis
and does not take into account the specific investment objectives of the specific person or group of persons. As some of the authors/contributors may have a personal interest in some of the funds commented on, investors should seek the advice of professional advisers regarding
the evaluation of any product, unit trust or other financial instruments, report, index, opinion or any other content contained herein, to ensure the investment instrument is suitable for them. In the event that investors choose not to seek advice from a professional adviser, they
should consider whether the investment instrument is suitable for them. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed
herein are subject to change without notice. iFAST Financial and/or its licensed financial advisers representatives may own or have positions in the funds of any of the asset management firms or fund houses mentioned or referred to in the article, or any unit trusts or Singapore
Government Securities bonds related thereto, and may from time to time add or dispose of, or may be materially interested in any such unit trusts or Singapore Government Securities bonds.

3. investment insight
by St ephanie t h n g
image source: stockxpert.com
*NB: Yield to Worst refers to the
➝ lowest potential yield that can be received
on a bond without the issuer actually de-
premium. The risk premium com-
ponent is particularly high now, faulting. (Source: Investopedia)
given increased volatility and un-
certainty. To arrive at an implied iFAST: What kind of returns and
default rate of 13.7%, we begin volatility can investors expect for
with a high yield index spread of 2009?
15.94 % as of 9 January, 3.13% for DH: Schroders forecasts the total
the long term average premium to return on the global high yield in-
Treasury bonds, plus an additional dex for the remainder of 2009 to
DH: The fund is actively managed 2.50% to reflect the elevated risk be in the range of 8% to 12%, with
with exposures rotated through premium (assuming 25% recovery elevated volatility similar to 2008
market sectors, depending upon a rate on defaulted bonds). throughout the year. Our total re-
combination of our economic out-
turn forecast is based on a starting
look, industry/issuer fundamentals This is outlined in the table be- yield of about 13.3% as of 16 Jan-
and the relative value of opportu-
low from J.P. Morgan. uary 2009, combined with some
nities across sectors. The fund is
Risk premium is much higher modest price depreciation due to
positioned defensively with about
now than in the past several reces- weak economic fundamentals, ris-
14% cash and 4% exposure to in-
sions, and the implied default rate ing defaults and investor risk aver-
vestment grade corporate bonds,
sion.
of 13.7% is higher than the actual
higher overall credit quality (aver-
default rate experienced during the
age BB- compared to B for the in-
iFAST: What would be the rationale
dex), including 16% underweight 2002 or 1991 economic downturns.
in bonds rated below B-, and a sig- for investors to buy into high-yield
nificant bias in favour of cyclically iFAST: What is the weighted yield- bonds now?
defensive industries. DH: Risk premiums are unusually
to-maturity for the fund?
high right now as investors demand
DH: As of 13 January, the yield-to-
a premium for higher uncertainty
worst* was 12.2%, and was 12.9%
iFAST: What are the default risks im-
and default risk. This extra premi-
as of 31 December 2008. We prefer
plied by the market now? How does this
um translates into an overall yield
yield-to-worst as more than 50%
compare with that of past recessions?
which is high enough to absorb ac-
of the high yield market is callable
DH: Implied default rates are no-
tual defaults and provide a cushion
and historical evidence suggests
toriously difficult to estimate as
against additional bad economic
the majority will be called. In all
yields imbed assumptions about
news, mark-to-market risk and il-
cases yield-to-worst will be equal
default expectations and recovery
liquidity from poor financial con-
to or less than yield-to-maturity.
rates as well as a highly volatile risk
HigH-yield spread estimate using a 25% recovery rate
and a 250bps liquidity premium
RecoveRY Rate Default Rate Default loss excess spReaD est spReaD pRemium foRecast
(100%-25%) x 8.0% = 600bps + 313bps = 913bps + 250bps = 1163bps
implied HigH yield default rate based on a 25% recovery rate
and a 250bps liquidity premium
actual spReaD excess spReaD pRemium Default loss RecoveRY Rate Default Rate
1594bps - 313bps - 250bps = 1031bps / (100%-25%) 0.137
source: J.p. morgan
74 |
February ~ July 2009
Article disclAimer: This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund’s prospectus. Any advice herein is made on a general basis
and does not take into account the specific investment objectives of the specific person or group of persons. As some of the authors/contributors may have a personal interest in some of the funds commented on, investors should seek the advice of professional advisers regarding
the evaluation of any product, unit trust or other financial instruments, report, index, opinion or any other content contained herein, to ensure the investment instrument is suitable for them. In the event that investors choose not to seek advice from a professional adviser, they
should consider whether the investment instrument is suitable for them. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed
herein are subject to change without notice. iFAST Financial and/or its licensed financial advisers representatives may own or have positions in the funds of any of the asset management firms or fund houses mentioned or referred to in the article, or any unit trusts or Singapore
Government Securities bonds related thereto, and may from time to time add or dispose of, or may be materially interested in any such unit trusts or Singapore Government Securities bonds.

4. ries had been significantly reduced seeking to reduce risk due to mar-
ditions (for example, dealers not
and were unable to satisfy alloca- gin calls and redemptions, similar
making markets as robust as prior
tions into high yield at year end.
to 2008). to the September through Novem-
The high yield market has an Indeed, industry-wide subscrip- ber period last year. We see 2009 as
average bond price of $59.93 and tions to high yield mutual funds the inflection period for high yield;
average coupon of 8.0%, resulting were sharply positive in the four full however, we recognize that sig-
in a 13.35% current yield. Divid- weeks in December and the first two nificant impediments for sustained
ing by the market duration of 4.11 weeks of January, at the same time recovery remain and that investor
years gives us a break-even yield as the positive news of US govern- sentiment is likely to remain frag-
change of 3.25%. That is, for in- ment providing financial support for ile and subject to sharp reversals,
vestors allocating out of cash, the GMAC and Rescap (bonds of both resulting in elevated volatility for
yield on the high yield index could issuers rose more than 100%) created much of the year. iFAST
go from 19.75% to 23.0% before it a favourable climate for high yields
has a negative total return. to perform well. However, significant
near-term hurdles for credit remain
iFAST: Do you expect high yield (economic data, new issue supply),
bonds to be one of the outperforming suggesting the rebound will be tem-
asset classes this year? Why? porary.
DH: Yes. Given the elevated start-
ing yield compared to other asset iFAST: What are the biggest risks
classes, high yield is well positioned faced by investors of high-yield bond
to outperform most other bond funds this year?
sectors in 2009, including Treasur- DH: We see the rising defaults as
ies, agencies and mortgage-backed the biggest risk to high yield in-
bonds and cash, and should also vestors in 2009. While Schroders
handily outperform equities should forecasts full year 2009 defaults
economic recovery be slow to take at about 12%, less than Moody’s
hold as we expect. latest prediction of 15.1%, the ac-
tual number of companies filing
for bankruptcy will be daunting. A
iFAST: From end-November 2008 till 12% default rate implies approxi-
6 January 2009, high yield bonds mately 30 companies per month
went up more than investment-grade will default, compared to just 4 to 7
bonds (source: FINRA-Bloomberg). defaults per month in 2008, creat-
ing a highly negative environment
What are the reasons behind this
for investors.
phenomenon?
DH: Nearly all non-Treasury bond Moreover, forecasts are for de-
sectors rebounded during this pe- faults to be clustered in economi-
riod. In general, sectors with the cally sensitive sectors such as re-
most severe underperformance tailers, auto parts and media, but
during the second half of 2008
the risk of negative surprises of
had the best returns in December
defaults in more stable sectors is
and the first week of January. We
significantly heightened.
view this as a typical response fol-
A second large risk comes from
lowing a sharp market movement.
another wave of selling by investors
In this case, overall dealer invento-
75
Important: See Disclaimer on Page 6 iFAST INSIGHT |
Article disclAimer: This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund’s prospectus. Any advice herein is made on a general basis
and does not take into account the specific investment objectives of the specific person or group of persons. As some of the authors/contributors may have a personal interest in some of the funds commented on, investors should seek the advice of professional advisers regarding
the evaluation of any product, unit trust or other financial instruments, report, index, opinion or any other content contained herein, to ensure the investment instrument is suitable for them. In the event that investors choose not to seek advice from a professional adviser, they
should consider whether the investment instrument is suitable for them. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed
herein are subject to change without notice. iFAST Financial and/or its licensed financial advisers representatives may own or have positions in the funds of any of the asset management firms or fund houses mentioned or referred to in the article, or any unit trusts or Singapore
Government Securities bonds related thereto, and may from time to time add or dispose of, or may be materially interested in any such unit trusts or Singapore Government Securities bonds.