Difficult year for high yield funds like City Merchants – High yield investors like City Merchants High Yield (CMHY) operated in choppy waters over the second half of 2018 as investors went on the defensive. Spreads between high yield and investment grade bonds widened and, by association, prices on these securities fell.
The company’s NAV total return for the year was –3.6% compared with a total return of –2.4% for the ICE Bank of America Merrill Lynch European currency high yield index and an average return of -2.3% for funds in the investment association sterling strategic bond sector. A decline in the premium to NAV saw the share price return –7.6% during the year.
Spread narrowing trend breaks
CMHY chairman, Tim Schofield, had this to say, in his note to shareholders: “2018 proved to be a challenging year for high yield investors. The familiar trend of ever declining yields seen in the prior years was decisively broken, and yields rose steadily during the twelve months under review. To put this increase in context, it is worth keeping in mind that yields had fallen to exceptionally low levels in 2017, levels which by historic standards appeared increasingly detached from the long-term characteristics of the asset class.
A number of themes weighed on the high yield market over the course of the year, perhaps the main source of unease stemming from the imminent prospect of a peak in the degree of stimulus provided by ‘quantitative easing’. Quantitative easing, whereby central banks undertake large scale purchases of assets, became a common feature of G7 monetary policy post-2008 as policymakers fought to restore financial market confidence. However, in 2018 this stimulus slowed, particularly in Europe where the European Central Bank (ECB) signalled its intention to rein in its monthly program of asset purchases.
This change in central bank policy, albeit gradual, came at a time of growing uncertainty regarding the outlook for economic activity. Tariff increases enacted in the United States and China caused much alarm, and though by November an uneasy truce was reached between President Trump and China’s Premier Xi Jinping, underlying tensions remained unresolved. Europe saw a particularly marked deceleration in economic activity, and toward the end of the year familiar concerns over the long-term sustainability of China’s debt-fuelled development model resurfaced. Brexit and concerns over sovereign risk in Italy compounded investors’ unease.”
Outlook more sanguine
Tim pointed to the price opportunity created by the high-yield sell-off in his outlook note. “It is the health, or otherwise, of the corporate sector which is ultimately the key determinant of high yield performance, and in this respect, there are grounds for cautious optimism. For example, the economic backdrop currently appears to be one of slowdown rather than widespread or protracted recession and while corporate profit margins are likely to have peaked in 2018, their decline over the coming year seems likely to be gradual. The re-pricing of the market in 2018 has undoubtedly provided greater opportunities to invest in bonds which provide sufficient compensation for the risk to investors.”
CMHY investment style
The manager seeks to ensure that the portfolio is diversified, having regard to the nature and type of securities (including duration, credit rating, performance and risk measures and liquidity) and the geographic and industry sector composition of the portfolio. The company may hold both illiquid securities (for example, securities where trading volumes are relatively low and unlisted securities) and concentrated positions (for example, where a high proportion of the company’s total assets are comprised of a relatively small number of investments). The objective is to deliver high income as well as capital growth by investing mainly in fixed-income securities. Equities can be invested in upto a maximum of 20% of total assets.
CMHY: Difficult year for high yield funds like City Merchants