Join our community of smart investors

Risking higher yield

FUND TIP: Aegon High Yield Bond Fund
January 13, 2011

BULL POINTS:

■ Strong total returns

■ Experienced manager

■ More resilient to inflation

BEAR POINTS:

■ Not the highest yielder

■ More volatile than sector peers

IC TIP: Buy at 51.51p

With low interest rates and indebted governments, investors are favouring corporate bonds, in particular high-yield bonds, as the area of fixed income to be in. High-yield bonds offer higher rates of interest than corporates with yields currently around 8 per cent.

"If slow growth and steady inflation persist in 2011, I think high-yield bonds can continue to generate attractive returns, especially as default pressures recede," says Andrew Wells, global chief investment officer of fixed income at Fidelity Investment Managers.

In its outlook for 2011 Standard Life Investments recommends a "very heavy" allocation to high-yield bonds, within a global portfolio with access to all major asset classes. Standard Life continues to favour sustainable yield as growth momentum in the global economy is weak by historical standards, and interest rates should be lower for even longer. "Although credit valuations are not as favourable as in 2009, spreads remain wide by historical standards and balance sheets are generally in good order for larger firms. Higher-yielding debt is becoming more attractive than investment grade."

IC TIP RATING
Risk rating:High
Timescale:Long term
Tip type:Value
What do these mean? Find out in our

If inflation does rise, high-yield bonds' higher interest rates mean they are more likely to stay ahead than better quality corporate bonds, while they often benefit when an economic recovery is underway. However, you should also remember that high-yield bonds are more likely to default than high-quality bonds. Although defaults have been falling recently, and expectations are that this will continue, this could be reversed, for example, if there is a double-dip recession or the European debt crisis worsens.

All of this means that if you have a high-risk appetite and a long-term investment horizon you could consider a high-yield bond fund.

Aegon High Yield Bond Fund has offered very strong total returns placing it among the top-three funds in the Investment Management Association's high-yield bond fund sector over one, three and five years. Its primary aim is to maximise total return rather than just income.

The fund's investment process adds value by asset allocation, duration, yield curve, sector allocation, stock selection and rating preference, and has a concentrated portfolio of 30-85 stocks. It can also allocate to higher-quality bonds and cash, and use derivatives.

The investment process is flexible with no long-term value or momentum bias and the fund aims to outperform through the cycle. The investment team forms top-down allocation views based on its combined experience. The fund's manager, Philip Milburn, takes these views on board but ultimately constructs the portfolio at his discretion, with bottom-up research. He and deputy manager Euan McNeil research all names in the portfolio backed by a team of around 18 analysts who can draw on additional specialists outside the UK.

Mr Milburn has been involved in the high-yield market since the late 1990s, and took this fund on in 2003.

Aegon High Yield Bond is not the highest-yielding fund in its sector, offering less than 8 per cent in contrast to more than 8 or 9 per cent for some peers. The concentrated portfolio makes the fund more volatile than some other high-yield bond funds, as well as having a more aggressive investment approach. For example, Mr Milburn is willing to take significant thematic bets when he has conviction, and the fund fell more than its sector average in 2008.

However, the defaults were not enough to prevent a strong recovery - the fund made a total return of more than 60 per cent in 2009.

Note that the fund's total expense ratio at 1.1 per cent is slightly higher than some of its competitors, creating a small headwind.

Key fund data:

AEGON HIGH YIELD BOND FUND A Inc NAV (SEOPAI)

PRICE51.51pSHARPE RATIO0.4
SIZE OF FUND£309.32m1-YR PERFORMANCE13.88%
No OF HOLDINGS77*3-YR PERFORMANCE8.65%
SET UP DATE1 March 20025-YR PERFORMANCE5.94%
MANAGER START DATE18 November 2003TOTAL EXPENSE RATIO1.10%
FEESInitial 4.5%, annual 1%YIELD7.90%
BETA0.83MINIMUM INVESTMENT£500
STANDARD DEVIATION16.97%MORE DETAILSwww.aegonam.co.uk

Source: Morningstar, *Aegon Asset Management.

Performance data as at 17 December 2010.

Top 10 holdings:

Holding Percentage
Inaer Aviation 9.5% 01/08/172.1
Care UK Health 9.75% 01/08/172.1
Conti-Gummi Finance B.V. 7.125% 15/10/182.0
Telenet Finance Lux 6.375% 10-15/11/20202.0
Exova 10.5% SNR 15/10/182.0
Codere Fin (Lux) SA 8.25% 06/151.9
Elwood Energy LLC 8.159% 07/261.9
International PERS 11.5% 6/8/151.9
Lottomatica Spa 8.25%-FRN 03/661.9
Unitymedia NRW 8.125% 1/12/171.8

Credit rating breakdown:

CountryPercentage
BBB10.7
BB42.5
B33.3
CCC10.3
C0.3
Not rated high yield2.7
Cash0.2