70 / 772
20
After a risk-led rally drove strong returns for high-
yield bond funds from
2009
through
2013
, the cate-
gory had a difficult year in
2014
. The group returned a
paltry
1
.
1%
on average last calendar year, and many
funds posted negative returns. The category returned
4
.
8%
on average during the first six months of last
year but fell
3
.
6%
during the last six months.
This second-half decline was driven largely by
plunging oil prices, which caused energy-related high-
yield bonds to decline almost
13%
in the last half
of
2014
. Following the sell-off, just more than
20%
of
the high-yield energy sector is trading at distressed
levels, with option-adjusted spreads over Treasuries
topping out at above
1
,
000
basis points, compared
with just
1%
of the sector six months ago. Energy
companies borrowed heavily following
2008
’s finan-
cial crisis, taking advantage of new drilling opportuni-
ties, high oil prices, and low interest rates, causing
the energy sector to increase from
10%
of the Bank of
America High Yield Master
II
Index at the end of
2007
to
15%
near its peak in
2014
. By comparison,
the energy sector makes up
8
.
4%
of the S
&
P
500
.
The late-year sell-off was exacerbated in December
when investors pulled
$9
.
3
billion out of high-yield
funds, the second-worst month of flows for the cate-
gory in more than
10
years. These massive redemp-
tions caused broad-based selling across all high-yield
sectors: Excluding the energy sector, high-yield
spreads widened by
93
basis points during the second
half of
2014
. Aside from the energy sector, funda-
mentals remain strong. Defaults remain well below
historical averages.
Many investors believe the sell-off has created
attractive opportunities, with the overall high-yield
market now yielding close to
7%
and the energy
subsector yielding more than
10%
.
For junk-bond funds, performance has largely come
down to the size of their energy weightings. The top
two Morningstar
500
funds during the full year and
second half of
2014
were
Fidelity Capital & Income
FAGIX
and
Vanguard High-Yield Corporate
VWEHX
.
Vanguard High-Yield Corporate’s Michael Hong held
a bearish view on natural gas prices, which in turn
led to a
10%
position in energy bonds. His fund
returned
4
.
5%
for the full year and lost only
0
.
4%
during the second half of
2014
, easily outperforming
the category over both those periods. Fidelity
Capital
&
Income benefited from an energy under-
weighting and its nonenergy equity holdings.
Fred Hoff, the manager of
Fidelity High Income
SPHIX
, was also light in the energy sector, as he
believed commodity-price exposure would put addi-
tional stress on high-yield issuers’ balance sheets.
Finally,
PIMCO High Yield
PHYDX
benefited from its
higher-quality mandate, and that fund held a
10%
position in energy-related bonds through
2014
.
Funds with higher energy exposure included
Janus
High-Yield
JAHYX
and
Metropolitan West High
Yield Bond
MWHYX
. Janus High-Yield fell
4
.
6%
during the back half of
2014
and squeaked out a gain
of
0
.
7%
for the full year. The fund held a
17%
stake
in energy bonds at the end of
2014
, which caused
most of the fund’s poor returns. Metropolitan West
High Yield Bond held a
20%
-plus stake in the energy
sector throughout last year and its returns suffered
accordingly, returning
0
.
33%
for
2014
and declining
3
.
7%
during the last six months.
We now hear more managers arguing that energy
high-yield bonds are a great bargain. Carl Eichstaedt,
comanager of
Western Asset Core Plus Bond
WAPSX
, told us: “I think there are some big opportu-
nities. There are some survivors and some companies
that may not [survive]; but if you identify those that
will survive, I think there is tremendous opportunity in
energy high yield.”
If the energy bulls are right, it could flip the script
in
2015
.
K
Contact Sumit Desai at
sumit.desai@morningstar.comEnergy Sell-Off Spurs Outflows and
Bargain-Hunting
Income Strategist
|
Sumit Desai