The commodities and energy sectors will experience more pain before positivity returns for high yield investors, according to PIMCO’s Andrew Jessop.
Citywire AA-rated Jessop, who runs the €3.6 billion PIMCO GIS Global High Yield Bond fund, said he expects the sectors to fall further after having experienced a torrid time over the past 12 months.
‘The past year has seen a huge dislocation of the metals and mining and energy sectors from the rest of the market and the fundamentals are not in place for a short-term recovery, which means we will hold on to our underweight in these sectors,’ he said.
He said exploration and production names have suffered particularly this year, with many having had to increasingly pay more to finance their lower graded debt. Jessop, however, sees justification in a higher default rate among riskier bonds being priced-in.
'The CCC-rated energy sector was the most hit in the summer and we think that for these companies we would need to see much higher oil prices at over $80 to avoid restructuring,' Jessop said.
At around $45 per barrel, the price for oil is trading at nearly half of last year’s price. The default rate for the whole US-high yield market sits at around 5% but is driven predominantly by the commodity-related sector, Jessop added.
'Many energy companies are coming under increased pressure as they finance themselves on an asset-backed borrowing basis on assets that are now depleting. It’s a borrowing spiral which will see more defaults in the CCC sector,' said Jessop.
For the coming year, Jessop expects oil to recover to $60 and $65 per barrel and will mainly be spurred by a slowdown in US oil production.
Less fundamentals, more technicals
The recovery the high yield market saw in October had less to do with an uptick in the US economy than a technical repricing after the summer sell-off, Jessop added.
He also said, given current market trends, increased trading activity through passive instruments should leave the market with greater volatility. 'The high yield market has always been a less liquid market but what has changed is the price dynamics, which is mainly driven by ETF growth.'
'Whilst we can definitely see a positive momentum at the moment, with cash flowing in and a good amount of technical strength, we think the market is going to remain volatile.'
The PIMCO GIS Global High Yield Bond fund returned 12.1% in US dollar terms over the three years to the end of October 2015. This compares to an 11.6% rise by its Citywire-assigned benchmark, the BofA Merrill Lynch BB-B Global HY Constrained TR, over the same period.