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Why investors should not ignore the benefits of high yield bond funds

Joanna Faith
Written By:
Joanna Faith

For investors looking for income, it may pay to move higher up the bond risk spectrum.

The world of low-interest rates on cash accounts is now a decade old and shows few signs of coming to an end. This means investors must continue to look elsewhere to earn an income from their savings.

Equity income funds (those that invest in companies that pay dividends) have typically been the first port of call for many, but there are other options: bonds, for example.

A bond is basically a loan. But instead of you asking the bank to lend you money, a company or a government asks investors to lend it money.

When it comes to bonds as an asset class, the recent uncertainty in markets has led to more cautious investors favouring those which are deemed less risky: those that are more likely to meet their loan repayments and give investors their money back at the end of the term of the loan. These are called investment grade bonds.

However, if investors want a higher income (or yield)  than these bonds may offer, they need to look at riskier companies because the riskier the company is deemed to be, the higher the yield the company needs to pay in order to attract investors. These are called high yield bonds.

Because the risks are higher, the amount of research required is also higher – to fully understand the company, it’s outlook and whether the risk is worth taking. This is where a good active fund manager can really make a difference.

Below are three funds we like which offer exposure to the high yield bond market:

Firstly, I  would highlight the Elite Rated Aviva High Yield Bond fund. Managers Chris Higham and Sunita Kara invest in 80 to 100 holdings and the strengths of the teams’ stock picking ability is evidenced by the low to non-existent default rate (when the company defaults on its loan).

Chris and Sunita look to target businesses which are robust enough to handle all market conditions, as well as focusing on companies which may have levels of debt other managers deem too high to invest in, but show the ability to generate cash to pay down this debt. The fund has a yield of 4.8%.

Another fund we like is the Baillie Gifford High Yield Bond fund managed by Robert Baltzer and Lucy Isles, which offers access to a portfolio of largely US, UK and European high yield bonds. The managers build a portfolio of 50-90 companies, looking for resilient businesses that can survive the full business cycle and have the ability to improve their financial health.  The fund has a yield of 4.2%.

For those who may want the additional diversification benefits of high yield bonds, but are wary of the additional risk, there are also opportunities in strategic bond funds. This sector allows fund managers the flexibility to switch between different types of bonds based on their outlook.

The Invesco Monthly Income Plus fund currently has half of its allocation in high yield bonds. Managers Paul Causer, Paul Read and Ciaran Mallon can use the full flexibility of the mandate to invest where they wish, with the macroeconomic environment often driving the managers’ positioning. In addition to investing across the fixed income market, the fund can also invest up to 20% in equities. The fund has a yield of 5.65%.

Darius McDermott is managing director of FundCalibre