Global high yield bonds are still an attractive investment despite having returned over 50 per cent through the first three quarters of the year, according to Aviva Investors.
"While recent returns may discourage some investors, we believe today's valuations continue to provide good opportunity," Aviva Investors US-based high yield portfolio manager Joshua Rank said.
"While spreads are nearly 1200 basis points tighter year-to-date, they are still roughly 775 basis points more than US Treasuries.
"This compares to previous peak spreads in 2002 of roughly 1100 basis points and a trough in 2007 of 250 basis points."
High yield bonds are also known as non-investment grade, speculative grade or junk bonds. They have a bigger risk of default but typically pay better yields than higher quality bonds.
The global high yield bond market on aggregate yields over 10.5 per cent today with cash coupons of 9 per cent, Rank said.
If spreads tighten 200 basis points over 2010 then returns on global high yield bonds can be over 17 per cent assuming no defaults, he said.
"Zero defaults is not our expectation but we do continue to think that defaults will decrease and lead to attractive returns over the next 12 months," Rank said.
Ratings agency Moody's is forecasting the default rate in global high yield bonds to peak at 12.6 per cent by the end of 2009 and then tumble to 4.27 per cent in August 2010.
"While we believe the 6 per cent drop may be slightly over optimistic given the portion of CCC and below rated debt in the market, the direction [of lower defaults] is a very positive indicator, especially given the fact that spread movements typically lead default rates by six to nine months," Rank said.
"The risk of depression has largely passed and the risk of the financial sector collapsing has most likely been avoided.
"Revenue growth entering into 2010 is paramount to continue the rally in high yield spreads."
Aviva Investors recommends balanced portfolios to have a moderate overweight to global high yield.
Rank helps manage the Aviva Investors Global High Yield Bond Fund. An Australian dollar hedged version of the fund is available to local investors.
