The Benchmark Causing Headaches for High Yield Investors

Investors in high yield fixed income could face added complexity when selecting funds and benchmarks following a recent index review, a fund manager has warned.

Andrew Wilmont, European high yield portfolio manager at Neuberger Berman, said investors could see “elevated risk” in some markets for “many months” as bond issuers and buyers adapt to a new set of indexes to be launched later this year by Bank of America Merrill Lynch (BoAML).

“Portfolio managers and their clients have a big decision to make regarding their choice of index.” —Andrew Wilmont, Neuberger BermanBoAML updated its high yield indexes at the end of last month, introducing a new category that only contains issuers “with a developed markets country of risk”.

The decision followed downgrades of a number of large issuers based in emerging markets, such as Brazilian oil and gas giant Petrobras and Russian gas company Gazprom. The companies were subsequently moved from investment grade to high yield indexes, where the size of their debt in circulation meant they dominated the benchmarks.

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BoAML’s new indexes mean investors can chose global high yield benchmarks in which emerging market companies do not feature, but they are not forced to exclude emerging market securities. BoAML previously opted to exclude Latin American companies from US high yield indexes in 2010 and 2011.

However, Neuberger Berman’s Wilmont said the move still created a “major new headache” for investors.

“While not all of the world’s BoAML-benchmarked high yield money is about to dump emerging market bonds, at least some of it will likely migrate to the new indexes,” Wilmont said. “Portfolio managers and their clients have a big decision to make regarding their choice of index.”

He said the benchmarks, while initially similar in construction, could diverge “possibly quite rapidly”, as the emerging market names in the legacy indexes make up a large proportion of issuance and create additional volatility. He cited the example of Petrobras, which he said was “about to try to auction off its offshore oilfields”, while Russian companies are focused on buying back bonds.

“Before this compromise, many portfolio managers expected to face an uncomfortable few weeks of elevated risk between the announcement that emerging markets would be excluded from BoAML’s high yield indexes and the actual implementation in October,” Wilmont said. “Now, having been given a choice over which benchmark to use, they arguably face similar uncertainty for many months more.

It’s all about location, location, location—even for real estate managers’ own headquarters.

According to Preqin’s data, fund manager location could have an influence on performance, particularly for funds with older vintage years.

Generally, London-based managers performed better than their US counterparts, the report said.

Preqin found UK funds first invested between 2004 and 2006 recorded a median net internal rate of return (IRR) of around 3%, compared to just 1% for overall real estate funds.

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San Francisco-based general partners (GP) even dipped into the negatives for funds with earlier vintages, falling to -3% in median net rate of return.

On the other hand, New York-based funds with the same vintage years were on par with those in London.

The spread in performance narrowed for funds that began investing from 2007 to 2009, Preqin’s data found.

During this period, London-based funds still topped the group in performance, at around 9% in median rate of return. Real estate funds managed by New York and San Francisco GPs followed closely behind, recording 7% and 6% in median rate of return, respectively.

Funds of more recent vintages—between 2010 and 2012—were neck-and-neck in performance, according to Preqin.

“As funds with later vintages are yet to fully deploy their capital or exit from their existing investments, the median net IRR of funds managed in each of these cities is likely to change over the next few years,” the report said.

New York-based real estate funds outperformed those in London and San Francisco, the data found, with a 16% median rate of return.

San Francisco-based funds’ performance jumped to about 15%, the report said, generating an 18 percentage point increase on those of vintage years from 2004 to 2006.

Median rate of return for funds based in London, however, dropped slightly to just under 15%.

Preqin real estate location