What are we looking for?
High-yield bond funds went through a period of high volatility in the middle of the year, but these funds that invest in speculative-grade debt seem to have stabilized. How do these funds stack up now?
We looked for the 15 high-yield fixed-income funds with the top returns for the year ended Sept. 30. U.S. dollar, segregated, pooled and duplicate versions of the funds were excluded. We included returns for the month of September to keep an eye on recent performance.
What did we find?
It's getting tougher to eke out gains in high-yield debt, even with debt issuance in the United States poised to hit a third calendar-year record in 2013.
The SEI U.S. High Yield Bond P posted the best annualized gain of 10.2 per cent in the one-year period.
"Returns will not be what they were in the past, just because [there is] a lower overall yield or coupon in the marketplace," said Richard Bamford, a senior portfolio manager at SEI Investments, although his view of the high-yield space is still favourable.
SEI's fund invests through four sub-advised fund managers who align with the parent fund's broader market view. Number Cruncher has excluded the fund in the past because it is sold as part of a portfolio of funds. But we've included it in this case to explore the U.S. high-yield debt market, which is showing signs of strength, such as posting low default rates. It has also experienced considerable volatility in the past year.
The most wild swings in retail U.S. high-yield debt came in May and June of this year when the speculation that the U.S. Federal Reserve would begin to taper its bond-buying program caused a lot of people to sell riskier assets.
"[For many weeks] there was more than $1-billion [U.S.] moving in or out of this category," Mr. Bamford said. This was an anomaly not driven by the fundamentals of the asset class, which have been strong, he noted.
High-yield companies have done a good job at strengthening their balance sheets since the 2008 crisis, and low interest rates have encouraged lots of debt refinancing, which provides financial flexibility.
Credit risk for investors has also been favourable. The default rate among below-investment grade U.S. companies was just 2.6 per cent in the third quarter, according to Moody's Investors Service Inc. The historical average is closer to 4.5 per cent, he noted.
But other factors are less favourable. Slow economic growth and global central banks injecting liquidity into the market mean that "every fixed income asset class is towards the low end of their historical yield level," he said.
Editor's note: An earlier version of the accompanying chart on high yield bond funds incorrectly showed the IG Putnam U.S. High Yield Income Fund as having a 10-year annualized return of 3.5 per cent. In fact, the fund has not yet been established for 10 years.