Bond ETFs and thus exchange-traded index funds on high-yield bonds are attracting increasing interest from investors. However, according to Marc Leemans of Degroof Petercam AM, investors do better with high-yield bonds in the active space than with passive high-yield ETFs.
The active-liability debate has now extended into the fixed-income space, and in doing so, into the high-yield bond segment as well. The asset class has attracted significant amounts of money since the beginning of the year, much of which has gone into passive exchange traded funds (ETFs) tracking high yield indices.
"Investors should not rely on the fact that passive instruments in the fixed income universe are subject to the same rules with regard to benchmark replication as equities", says Marc Leemans, fund manager high-yield strategies at Degroof Petercam Asset Management (DPAM). "The indices underlying the ETFs, such as the Bloomberg Barclays Liquidity Screened Euro HY Index, only take into account the most liquid part of the overall market for high-yield bonds. Because liquidity is important for ETFs to keep spreads low. However, the most liquid part of the market is often also the most expensive and potentially heavily trafficked."
So, Leemans says, investors should be aware that by buying a high yield ETF they are not taking the same exposure as they would with an actively managed fund and are more likely to invest only in the premium part of the market, while taking in many interesting sectors or. within industries completely neglect individual interesting titles. "High-yield ETFs tend to underperform their respective index by an average of about 60 basis points. This can be attributed to the fact that they are also burdened with fees. In addition, an ETF must process inflows and outflows of funds immediately and thus faces bid-ask spreads that can have a strong impact on performance", says Leemans.
"Active" better in almost three quarters of all cases
The high yield team at DPAM, multiple winner of the Scope Investment Awards, compared a sample of broadly marketed European high yield funds with the three largest European high yield ETFs over the past six years. It found that at least half of the actively managed funds outperformed their counterparts in the ETF universe. Looking at cumulative performance over various time periods since 2013, at least 70% of actively managed funds outperformed ETFs.
One reason is that active fund managers can wait tactically when the market is expensive and also benefit from premiums on new issues on the primary market. Because actively managed funds are not tied to indexes and do not track the market in its full depth like ETFs, they can take advantage of the full diversity of the market segment, generating value beyond just index performance. In this respect, the telecommunications and automotive sectors currently offer particularly high potential.
Individual stocks with attractive risk-return profiles
"Thanks to our fundamental research, we can find smaller issuers or those with weaker ratings away from the index mainstream, while still offering good quality and attractive risk premiums", explains Marc Leemans. Among them, the expert counts, for example, Altice Holding, a Dutch issuer from the telecom sector. The company is well positioned in terms of quality, is solidly servicing its bond coupons and has its refinancing risk under control.
Leemans also likes Belgian cable network operator Telenet NV and United Group BV, which is active in the Balkans, as well as suppliers Schaeffler (Germany) and Faurecia (France) from the automotive sector. The current valuation of the high-yield securities they issue offer active, risk-management-oriented managers an attractive reward for the risk they have taken, which pure index investors cannot tap for themselves.