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Marret cuts high yield distribution, sounds dire warning

Traders talk next to electronic boards at the stock exchange in Madrid June 12, 2012. Spanish government bond yields rose close to euro-era highs on Tuesday as relief over a bailout for the country's banks quickly turned to concern over how easily it will be able to access debt markets in the longer term.

Andrea Comas/REUTERS

Venerable fund manager Barry Allan is making a big bet on the market. A big scary one.

Expecting the sovereign debt crisis to spread from Europe to Japan to the U.S., and earning minimal returns on his supposed high yield portfolio, Mr. Allan has cut the distribution on his flagship fund.

Effective July 31, the Marret High Yield Strategies Fund will distribute five cents per unit each month, down from the current level of 6.7 cents per unit.

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"Yields in the marketplace have collapsed well below beyond what anybody reasonably expected" when the fund launched in 2009, Mr. Allan said on a conference call with money managers Tuesday morning.

When the high yield fund launched in June 2009, returns were close to 14 per cent, making it easy to set a return target of 8 per cent for investors. But with major sovereign debt markets -- the U.S., Germany, the U.K. -- trading in the 1-to-2 per cent range, Marret isn't even earning its distribution anymore anymore. Returns on the high yield index today are just under 7.8 per cent.

Because the market noticed this, the high yield fund has traded with a lot of volatility in the past few weeks -- much more than at any time over the past three years, dating back to inception.

But don't be mistaken, it isn't just one fund that's having problems. Mr. Allan is worried about the entire high yield environment. "The risk in the marketplace well exceeds the returns available," he said. "People are reaching for yield and taking risks that they don't want to take."

His point is a simple one: back in 2009, investors in high yield products got paid 14 per cent for risky products. Today they may make half of that, and yet Mr. Allan thinks the bond markets are just as shaky.

"We fundamentally believe that we're in a global sovereign debt crisis. Europe is just the first stool. Japan and the U.S. are the other two legs," he said.

Mr. Allan's thesis: the euro zone is about two-thirds of the way through its crisis. Once that region gets its books sorted, the capital that has fled to places like the U.S. will repatriate, and that will light a fire under other countries' debt problems.

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"I think the financial markets are really expecting some political will to show up in the United States to start lowering the deficits, and our view is that we can't find a country that has voluntarily lowered its debt-to-GDP ratio. They only do it after the markets force them to do it," he said, citing previous examples such as Canada during the 90s, Argentina, and now euro zone countries.

For all these reasons, Mr. Allan has started building up a cash position as he sells riskier investments. Today, cash comprises about 35 per cent of the total high yield portfolio -- however, this metric is a bit skewed because the fund employs a long/short strategy. Some of that cash might be used to cover some shorts, for instance.

On the call, Marret's plan to cut distributions was generally understood given the market environment, but that doesn't mean everyone was happy with it. As one conference call participant pointed out, Marret raised $415-million over two issues for its high yield fund in the past year. Why? And if investors' money is going to just sit in cash, why not give it back to them?

Mr. Allan didn't duck either of the questions. He admitted that he simply didn't believe the euro zone would flare up again until the second half of the year, and he argued that he has used the cash strategy before. In 2007 he thought the market was shaky and sold off a lot of his investments, which ultimately allowed the fund to outperform its peers in 2008 by virtue of simply losing less money.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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