High yield bond fund: Bargain bonds make a comeback

Yuri Bender profiles the BNP Paribas Parvest European Bond Opportunities fund, which gives ‘fallen angels’ – downgraded household-name corporate bonds that used to be well respected – a second chance to fly high. High yield debt, the much-maligned asset class peddled by the junk bond kings of the late 1980s, is enjoying a new lease of life and respectability. “The financial environment has become more complex and volatility has increased,” says Christophe Auvity, manager of a new product from BNP Paribas Asset Management (BNP PAM). “Fixed income markets have gained in depth and breadth in terms of credit signatures, leading to the development of strategies based both on yield curves and credit risk. We believe corporate bond investments should be more resilient than government bonds.” It is this belief that has led to the launch of Mr Auvity’s euro-denominated, Luxembourg-registered Parvest European Bond Opportunities fund, a more opportunistic, slightly higher volatility alternative to BNP PAM’s core Parvest European corporate bond fund. The latter E100m fund has slightly outperformed its benchmark over the last year. Market declines According to Mr Auvity, who has been managing European bonds for 10 years and heads a five-person corporate bond team, three consecutive years of market declines have led to a growing number of “fallen angels”. “High yield bonds are coming back to the foreground after their 1980s crash and their management has increased in its maturity and professionalism. We think the moment has come to invest in these types of bonds,” he says. Fallen angels are issuers who have seen their rating downgraded from investment grade to high yield. “They are usually large companies and therefore capable of achieving the highest credit ratings, because of their nature, the size of their balance sheet and their issues,” says Mr Auvity. His key assertion is that while these issuers account for a significant part of the high yield bond universe, few investors take an interest in them, even though they are often household names such as Vivendi Universal and Ericsson. According to the corporate bonds team at BNP PAM, in 2002, these securities accounted for 42 per cent of high yield bond issuance. A subsequent joint analysis by the investment management and marketing teams recommended the reshaping of the Parvest European High Yield Bond fund into the Parvest European Bond Opportunities fund. The recrafted fund will be marketed through banks, asset managers and insurance companies. But the Parvest sub-funds structure also allows an institutional share-class to be offered to pension funds and charities. The annual management fee is 0.9 per cent. The distributors will be hoping performance improves. The high yield fund lost 30.37 per cent over the last three years, measured against the Lehman Pan-European high yield index which lost 17.16 per cent, according to Standard & Poor’s. Investment Process The investment process involves maximising absolute performance through investing in European fixed income. A roving mandate gives freedom at all times to select the best strategies in terms of issuers. The permitted investment universe comprises bonds with “ratings between the lowest echelons of investment grade issuers, and the highest grade of the high yield category.” In terms of credit ratings, the manager defines the universe as BBB+ to CC, with a maximum 10 per cent allocation to CCC and CC. The investment approach particularly seeks opportunities for capital appreciation of the debt instruments. These are predominantly securities of major corporations, which have recently been downgraded, but for which BNP PAM analysts express a positive view. “Our analysts know these companies well and have much information about them,” reveals Mr Auvity. Downgradings may have several causes, including the adverse economic climate, cyclical slowdowns, costly acquisitions or financial scandals. Internal analysis Analysis of the bonds is mainly internal, in collaboration with BNP PAM’s 12-strong equity research team, with external reports used as complementary support. “What is essential is the issuers’ redemption capacity,” says Mr Auvity. He also draws attention to the concentrated, short-term, cashflow-led analysis of bonds, as opposed to the macroeconomic long-term approach used for equities. The team’s favourites currently include:

• US car industry bonds – as it is a cyclical sector – including Ford and General Motors (both rated BBB-).
• Telecom bonds – as this sector has been restructured – including France Telecom and Olivetti (both rated BBB-).
• Alcatel, which should meet its commitments this year; and AHOLD, which has suffered the effects of a financial crisis, though its core value is not in question. (Both bonds are rated B.) Risk and reward Risks associated with this product, though controlled, are far from minimal. The fund has been assigned a two out of three rating for volatility, estimated at between 10 and 20 per cent. In addition to interest rate risk and currency risk for non-euro European bonds of up to 10 per cent, there is a substantial credit risk. “It could happen that some issuers fail and do not pay off,” says Mr Auvity. European insolvency procedures lag behind US standards and high yield bonds may also lack liquidity. While companies rated investment grade can be overvalued, default risk is low and allows profit from micro-economic improvements. Interest rate risk of fallen angels may be greater, but they offer attractive yield potential.