Generally speaking, faster-than-predicted rate rises will not be good for bonds.
“It is important to remember, however, that a rising rate environment is not necessarily detrimental to high-yield market spreads,” she points out.
“While spreads on investment grade corporates, mortgage-backed securities and emerging market sovereigns tend to be positively correlated to government yields through the cycle, spreads on the high-yield index tend to tighten when government yields rise.”
She suggests: “Although the strength of this relationship varies over time, the inverse correlation likely reflects the idea that stronger economic conditions typically lead to higher Treasury yields and tighter spreads on risk assets, all else being equal.
“We recognise, however, that this relationship tends to degrade at sufficiently tight spreads and, as such, requires thoughtful consideration when it comes to portfolio positioning.”
Ms Strasser thinks lower quality high-yield remains in a position to offset a rise in interest rates, in spite of material tightening over the past few months, although she acknowledges that higher quality high-yield is still susceptible to higher interest rates.
“Ultimately, we expect 2018 high-yield returns to approximate current yields, as spread tightening is offset by upward pressure on rates, and below-average defaults lead only to modest credit losses,” she concludes.
With so many investors piling into fixed income funds to help meet their income targets, managers will be keeping a close eye on spreads.
Anthony Rayner, co-manager of the Miton Cautious Monthly Income fund, expects spreads to start widening eventually.
He says: “Spreads between corporate, high-yield and sovereign bonds remain tight in a multi-year context, reflecting a positive environment for corporates and low sovereign interest rates.
“Higher sovereign interest rates will likely put pressure on spreads to widen at some point.”
eleanor.duncan@ft.com
