ANALYSIS-Junk corp debt draws investors with steady returns

LONDON, May 13 - In a rush to add risk back into their portfolios, high-yield corporate bonds are grabbing the attention of asset managers drawn by equity-like returns with lower volatility during both recession and economic recovery.

Corporate bond issuance is on track for its third biggest year ever with many companies in the hunt for funding, adding depth and liquidity to a market hit hard by the credit crisis.

Asset managers, who have stayed defensive in cash and government bonds for months, are under pressure to act after a near 40-percent rally in world stocks since mid-March.

Corporate bonds, which give similar or better returns to stocks and offer lower volatility when the global economy is either in recession or recovery, offer them a way of adding risk as worries persist about further economic slowdown and a possible pullback in stocks.

According to Schroders data which analysed equity markets since 1950 and high-yield corporate bond performance since 1983, high-yields give an annualised excess return over cash during a recession of 11.6 percent with volatility at 8.5 percent.

Equities return 9.9 percent but volatility is high at 14.6 percent. During a recovery cycle, high yields return 6.4 percent for volatility of 6.4 percent, compared with equities which give return of 8.6 percent and volatility of 13.7 percent.

"Bonds by their nature are less risky than equities. We see relative value in corporate bonds. We want to focus on corporate bonds more before raising equity exposure," said Aaron Gurwitz, head of global investment strategy at Barclays Wealth.

"Credit portfolios should be highly diversified and actively managed," he said, adding that he preferred to move up to high yield from investment grade bonds to take risks while investors should limit their exposure to a small percent per issuer.

Barclays Capital's high-yield index is extending its gains after turning in its best performance ever in April with a rise of 12.1 percent.

The index is up 23.3 percent this year, compared with an already impressive 18.8 percent rise for 2008.

The European mostly junk-rated credit protection index -- the iTraxx Crossover -- has fallen more than 30 percent since early March to about 700 points last week, its lowest since October. This reflects the falling cost of hedging against defaults for a lower-rated European companies.

"It is now leading the rally, as the return of risk takers favours high-yields assets first," Societe Generale said in a note to clients."

Corporate bonds generally have plenty of offerings to meet investor needs. This year is on track for the third-best year in history, according to Societe Generale, which estimates new issuance as of May 5 stood at 139.5 billion euros ($190.2 billion).

The top two years were 2001 at 200 billion euros and 2003 at 165 billion euros.

According to Barclays Capital, year-to-date supplies of U.S. high-yield debt totalled $29.3 billion.

Another factor making high-yield debt attractive is perceived mis-pricing in the market as it still anticipates an economic scenario which is worse than the Great Depression.

According to Credit Suisse, high-yield bonds are discounting a default rate of around 47 percent over the next five years, even assuming a low recovery rate of 20 percent.

This is slightly higher than the peak rate during the 1930s, a period when nominal gross domestic product halved.

EYE OF STORM

UK-based private banking and asset management firm Kleinwort Benson recommends investors with an appetite for risk look at high-quality Residential Mortgage Backed Securities (RMBS).

Similar to corporate bonds, this market has been in the eye of the storm after the fallout in the U.S. subprime mortgage market led to the financial crisis.

Triple-A rated RMBS currently yields around 18-22 percent per annum and allows investors to receive cash even as many homeowners in the pool default on their mortgage loans given its high status in the capital structure.

"We consider this high yield ... It may be too early to go into high-yields but that is the next step. We are at the top end of the investment grade and we will slowly increase our exposure to high yield," said Natalie Merrens, head of product advisory at Kleinwort Benson.

"The U.S. government is directly targeting this market. The U.S. is committed to bringing long term rates down. If this market starts to stabilise, liquidity comes back to the market."