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Bonds: High yield runs ahead
It appears demand for credit-risk has come back, at least to an extent. Whether looking at funds focussed on US dollar, Sterling, or Euro debt, high-yield funds (which focus on below-investment-grade credits) soundly beat all other bond categories in the first quarter. This stood in contrast to broad corporate bond funds, which were the worst performers across the board, dragged down in part by significant exposure to the financials sector. In the case of high-yield, it's worth noting that the default rates implied by yields at their peak were extraordinarily high, as much as 35% in some markets, which would by far eclipse the highest default rate on record. That suggests there was strong value to be had for intrepid investors, and may have inspired bottom fishing by investors, helping spreads to narrow.
| Morningstar Category | Total Ret 3 Mo (Qtr-End) GBP | Total Ret 3 Mo (Qtr-End) EUR | Total Ret 3 Mo (Qtr-End) USD | Total Ret 3 Mo (Qtr-End) JPY |
|---|---|---|---|---|
| Sterling High Yield Bond | -1.31 | 3.01 | -1.61 | 7.20 |
| Sterling Government Bond | -1.72 | 2.58 | -2.02 | 6.76 |
| Sterling Global Bond | -2.11 | 2.17 | -2.41 | 6.33 |
| Sterling Diversified Bond | -3.00 | 1.24 | -3.30 | 5.36 |
| Sterling Corporate Bond | -5.48 | -1.35 | -5.77 | 2.67 |  |
Government bond funds also continued to do relatively well across the board. In terms of duration (a measure of a bond fund's sensitivity to interest-rate changes) short-duration funds continued to outpace their longer peers. This is to be expected in an environment where rates are easing: Bond prices move inversely to rates, so funds with less interest-rate sensitivity (shorter duration) fare better when rates are falling.
| Morningstar Category | Total Ret 3 Mo (Qtr-End) GBP | Total Ret 3 Mo (Qtr-End) EUR | Total Ret 3 Mo (Qtr-End) USD | Total Ret 3 Mo (Qtr-End) JPY |
|---|---|---|---|---|
| Dollar High Yield Bond | 2.95 | 7.45 | 2.63 | 11.83 |
| Dollar Short Bond | 0.93 | 5.34 | 0.62 | 9.63 |
| Dollar Government Bond | -0.43 | 3.93 | -0.73 | 8.16 |
| Dollar Diversified Bond | -0.98 | 3.35 | -1.28 | 7.56 |
| Dollar Global Bond | -2.01 | 2.27 | -2.31 | 6.44 |
| Dollar Corporate Bond | -4.06 | 0.14 | -4.35 | 4.22 | |
| Morningstar Category | Total Ret 3 Mo (Qtr-End) GBP | Total Ret 3 Mo (Qtr-End) EUR | Total Ret 3 Mo (Qtr-End) USD | Total Ret 3 Mo (Qtr-End) JPY |
|---|---|---|---|---|
| Euro High Yield Bond | -0.63 | 3.72 | -0.93 | 7.94 |
| Euro Inflation Linked Bond | -3.32 | 0.91 | -3.61 | 5.02 |
| Euro Government Bond | -3.75 | 0.46 | -4.04 | 4.55 |
| Euro Short Bond | -3.77 | 0.44 | -4.07 | 4.53 |
| Euro Global Bond - Hedged | -4.08 | 0.12 | -4.37 | 4.19 |
| Euro Global Bond | -4.58 | -0.41 | -4.88 | 3.64 |
| Euro Diversified Bond | -4.62 | -0.44 | -4.91 | 3.61 |
| European Bond | -4.76 | -0.60 | -5.06 | 3.45 |
| Euro Long Bond | -5.82 | -1.70 | -6.11 | 2.30 |
| Euro Corporate Bond | -6.51 | -2.42 | -6.80 | 1.55 | |
Q1: Industry Trends
Continuing a trend from 2008, there was a large number of fund class closures in 2009's first quarter. We expect this scaling back to proceed for some time as we believe fund groups over-expanded during boom years and offered far too many niche funds that will be unable to achieve the scale needed to operate profitably. 1,439 fund classes were liquidated or merged into other classes in the quarter. That's a marked year-over-year increase with just 891 being liquidated or merged in the first quarter of 2008. The trend of increasing closures is made clear in the chart below.
We also note that asset managers themselves are undergoing a wave of mergers and acquisitions fostered by market pressures. BNP Paribas, Fortis, Societe Generale, GLG Partners, Credit Agricole, Credit Suisse, Aberdeen, New Star, Henderson, and F&C among others are all involved in deals. This heightened activity is likely to result in further fund mergers and liquidations: As houses come together, they will need to reduce or eliminate overlap in their fund line-ups to achieve cost savings and economies of scale.
Ultimately, we think the scaling back of fund offerings is needed. However, we urge investors and regulators to monitor the situation carefully. We have too often found that merger activity among fund companies leads to poor outcomes for fund investors. This is because significant decisions are taken primarily on the basis of what is best for the fund house as a business, and regard for fund-shareholders' needs can be lost in the process. For example, investors may suddenly find themselves with unwanted or unintended risk exposures if their fund is merged into a different offering or its mandate is changed; asset bloat may hamper liquidity-constrained fund managers if they are handed new pots of money to run as part of a merger; investment talent may leave or be asked to leave; and/or investors may see that their fees have risen as an acquiring firm attempts to recoup its investment faster. In such situations, there are few protections for fund investors, which points to a rather large failing in the current regulatory system.
