Credit quarterly newsletter
Focus on quality
Euro high yield has posted excellent returns so far this year. Does that mean it’s now too late to allocate to the asset class? In this first edition of our credit newsletter we explain why we believe it is still a good time to invest, but why a more selective, conservative approach to high yield is necessary from here – and why Kempen (Lux) Euro High Yield Fund (hereafter Kempen Euro High Yield Fund) could be an excellent option.
A rollercoaster ride
It’s been a rollercoaster ride for credit investors over the past 18 months. For several years prior to 2018, investors had been successfully chasing yield against a backdrop of ultra-low interest rates and accommodative central banks by moving up the risk scale and allocating to high yield. This proved rewarding until early last year, when central banks became much more hawkish and concerns about economic growth surfaced. The result was that 2018 turned out to be the worst year for credit investors over the past decade.
And yet in 2019, central banks have become more dovish once again and corporate bonds have rebounded spectacularly, erasing most of last year’s losses in just three months.
This all leaves credit investors in a quandary. High yield valuations are nowhere near as compelling as they were a few months ago, but the yields of higher-rated bonds are not attractive either. So how can they now earn a decent return?
We believe it’s still a good time to allocate to high yield, but that investors now need to tread more carefully. With central banks expected to keep interest rates lower for longer, the search for yield looks likely to continue. However, confidence in economic growth and the strength of corporates’ profits has been hit, so it seems unwise to move too much up the risk scale at this point in the cycle. In our view, investors can still earn a decent return by avoiding the riskiest issues within the high yield universe or by moving from an aggressive to a more defensive high yield manager. One way to do this is through an allocation to Kempen’s Euro High Yield Fund.
Kempen Euro High Yield Fund: a conservative option without foregoing return potential
The Kempen Euro High Yield fund is very much a conservative option when it comes to investing in euro high yield – our philosophy in managing credit is “alpha by control” – but that doesn’t mean foregoing return potential. The fund has shown its ability to outperform in both rising and falling markets: having been launched in July 2017, it has outperformed the benchmark³ in the sharply contrasting conditions of 2017, 2018 and 2019.
We do this by taking a very active approach to credit management, combining a top-down risk assessment with bottom-up issue selection. Our portfolio is always well diversified, focusing predominantly on quality issues and managing downside risk.
Standing out from the crowd with BB bonds
But what really makes the fund stand out from the crowd is its focus on BB rated bonds, which we believe offer the most attractive risk-return profile within the euro high yield universe. BBs are the highest-rated high yield bonds and suffer fewer defaults than other areas of the market. They also tend to weather economic shocks much better than weaker issues.
What’s more, as they’re close to the boundary with investment grade, this segment can be home to structural anomalies for talented investors to exploit: bonds moving from investment grade to high yield (so-called ‘fallen angels’) often rebound after their downgrade, while those upgraded to investment grade status (so-called ‘rising stars’) tend to outperform. Exploiting these opportunities can result in strong risk-adjusted returns and outperformance.
“We believe it’s still a good time to allocate to high yield, but that investors now need to be more careful in their search for yield.”Rik den Hartog, Senior Portfolio Manager
Navigating different markets
If we manage the fund so conservatively, how have we been able to outperform in 2019’s strongly rising market? Because we always carefully consider the top-down environment and adjust our positioning as appropriate using our market scoring framework. At the start of the year we became more optimistic about high yield’s prospects: the supply of high-yield bonds dropped as many companies deemed it too expensive to issue new bonds and turned to the loan market, and inflows into the asset class increased. This led us to increase our portfolio’s risk profile. But now, with valuations having become more expensive and economies struggling, we are becoming more defensive.
Doing good with your investments
Another good reason to consider investing in the fund is the way we integrate ESG throughout its process, helping you to do good with your investments. Relatively few high yield funds take a responsible approach, but we do so in three ways: by excluding companies involved in controversial practices, by incorporating ESG criteria in our fundamental ranking of each issue in our universe, and by engaging with firms we invest in to help them improve their ESG practices.
A long history in euro credit
While we only launched our high yield fund in 2017, Kempen has a history of over a decade in Euro credit management, steadily increasing the range of strategies we’ve made available to our investors over that time. Today, our Euro Credit team looks after more than EUR 5 billion of assets on behalf of our clients. Teamwork is key to the way we manage our strategies, and with this in mind we combine the roles of portfolio manager and analyst. We implement our long-standing investment philosophy and process in a disciplined manner with intensive cooperation and clear responsibilities.
What’s more, our abilities are recognised by external experts: in March 2019 our Euro Credit team and the Kempen (Lux) Euro Credit Fund were awarded a Morningstar Gold rating for the quality of their investment process and the strength of the team. We’re currently the only European credit manager to have received this top ranking from Morningstar.
¹ As per 31 March 2019
³ BofA Merrill Lynch Composite Index
Kempen (Lux) Euro High Yield Fund (the “Sub-Fund”) is a sub-fund of Kempen International Funds SICAV (the “Fund”), domiciled in Luxembourg. This Fund is authorised in Luxembourg and is regulated by the Commission de Surveillance du Secteur Financier. Kempen Capital Management N.V. (KCM) is the management company of the Fund. KCM is authorised as management company and regulated by The Netherlands Authority for the Financial Markets.
Paying agent and representative in Switzerland is RBC Investor Services Bank S.A., Bleicherweg 7, CH-8027 Zurich, Switzerland. The Sub-Fund is registered with The Netherlands Authority for the Financial Markets under the license of the Fund.
The information in this document provides insufficient information for an investment decision. Please read the Key Investor Document and the prospectus. These documents as well as annual report, semi-annual report and the articles of incorporation of the Fund are available free of charge at the registered office of the Fund located at 6H, route de Trèves, L-2633 Senningerberg, Luxembourg, at the offices of the representative in Switzerland and on the website of KCM (www.kempen.com/investmentfunds).
The Sub-Fund is registered for offering in a limited number of countries. The countries where the Sub-Fund is registered can be found on the website. The value of your investment may fluctuate. Past performance provides no guarantee for the future. The performance shown does not take account of any commissions and costs charged when subscribing to and redeeming units.