Watson’s Horsfall recommends high-yield debt

GLOBAL – High-grade high yield debt is a ‘closet equity’ and should be considered as alternative, says Nick Horsfall, head of fixed income at consultant Watson Wyatt.

A long-term advocate of replacing equities with alternative investments, Horsfall addressed a high-yield conference hosted by Muzinich & Co. in London, saying that “high yield debt is a closet equity in that, it is not a high grade safe asset, but is a return-chasing asset. The bonus being that it offers more protection than the equity market”.

He recommended a 5% to 10% weighting to high yield debt in a portfolio for those with more than 50% in equities, and highlighted the fact that over a five-year period a switch of 10% out of equities and into high yield would have seen risk reduced by 7-8% in either bull or bear market.

US high yield is less risky than US equities, says Horsfall. While both asset classes are linked to the health of the US economy, debt will have a prior call on assets if the sponsor fails. To achieve a negative return there needs to be around 15% default per annum. “Imagine what that would do, and did, to the equity markets,” says Horsfall.

The risk reduction in high yield is very attractive for a very modest give up in excess returns. As George Muzinich, president of Muzinich & Co., pointed out, high yield has been the best performing asset class in fixed income on a relative and absolute basis over the last 100 years.

Muzinich recommended investors to think about reducing equity exposure, and in debt, barbelling – moving up the credit spectrum in corporate debt and down at the other end into high yield.

Clarifying that Watson recommends high yield debt at the high end of the sub-investment grade credit spectrum, Horsfall said he was “frustrated” that those allocating to Single A and Triple B credits would not consider moving further down the credit curve.

“It is amazing that some will not consider anything beyond bonds and equities”, he said, although added that the Myners report in the UK had encouraged some investors to look further afield, and that “smart pension funds are diversifying away from equities to add value”.

Among other alternative asset classes promoted by Horsfall are emerging market debt, CDOs/CLOs, property, and hedge funds.

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