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16 08 Fidelity Global HY Update .pdf


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Peter Khan
Portfolio Manager
Global High Yield

AUGUST 2016

Global High Yield Update
Since the February lows, Global High Yield (HY) has rebounded by 16%. A rally in energy and
commodity prices has supported the US HY market which has been the main catalyst for this
substantial tightening of spreads. Peter Khan, manager of Fidelity’s Global High Yield strategies,
provides an overview of his outlook for the asset class and an update on fund positioning below.
Outlook: well balanced in the medium term
The hunger for yield remains in place supporting flows into the asset class. To date, Asia and Europe have led
the way and in the months ahead, accommodative monetary policy should continue to benefit both risk and
income producing assets. Against this backdrop, supply has been subdued, at levels well below the last 2
1
years and at only 50% of the 2015 run rate. As a result form a technical standpoint the market remains well
balanced and underpinned in the medium term.
Over the next 3-6 months we find it hard to envisage a scenario where these returns will be replicated. It would
require bullish assumptions about economic growth, fiscal policies transitioning to support growth, a material
fall in forecasted defaults or a continued rebound in commodity prices. On the latter, over the past few weeks
we’ve seen a breakdown in the correlation of commodity prices and risk assets (Chart 1). The ability of broader
risk markets to remain immune to weaker commodity prices going forward will determine whether we’ll
comfortably clip our coupon or need to fasten our seatbelts.
1

Source: Deutsche Bank. Data as of 30 June 2016, based on Global HY USD denominated issuance.

Defaults: little margin for error
At the lows in February, the market implied global HY defaults would rise to around 9% over the next 12
months and indicated an 80% probability of a US recession. Currently, the market is pricing in a default rate of
2
3.8% slightly lower than the Moody’s forecast of 4.2% over the 12 months. Defaults are already into
Chart 1: The relationship between commodity prices
and risk assets has diverged recently
80%

1 yr rolling correlation

Oil price

Chart 2: Slimmer margin of error for lower rated; BBs
still offer default adequate compensation
0

70%
20

60%
50%

40

40%

300
250

Basis Points

266
226

213

200
152
150

30%

60

20%
10%
0%

100

80

50

100

-

19

-10%
-20%

120
'11

'12

GHY

'13

S&P

'14

'15

WTI RHS (Inverted)

Source: Fidelity International, Bloomberg, BofA Merrill Lynch Indices, 29 July
2016.

-26

-50
Ba
Stable Default

B

Caa-C

Rising Default

Source: Fidelity International, Moody’s Research, BofA Merrill Lynch
Indices, Bloomberg, data as at 21 July 2016. Spread Premium Conditional
to Default Regime from 1970.

double digits in the energy sector but have been relatively contained. In US HY more broadly, there are some
signs of balance sheet repair with leverage coming down, but this comes from a high base as issuers levered
up massively post the financial crisis.
Our spread premium model gives an indication of the amount of spread we need to compensate for defaults in
each rating bucket based on default cycles back to 1970. In a rising default environment, we are adequately
compensated in the BB bucket and we have been rotating up in quality in the portfolio to reflect this (Chart 2).
Lower down the ratings spectrum, there is now a much slimmer margin for error and we have been
consolidating positions here into high conviction names.
2

Source: Moody’s Research, June 2016.

Risks: impact as yet indeterminate
There are numerous risks facing high beta assets into year end. At a fundamental level, shrivelling earnings
growth and margins reaching a plateau leave valuations, particularly in the equities market, vulnerable. This
combined with the lower level of absolute yields and spreads leaves little margin for error. In addition,
normalisation of US monetary policy alongside the US elections is unlikely to be a smooth ride. China is also a
concern. Its debt dependence is a longer term issue but a slowdown in growth or disappointing data will
require closer examination. Finally, the technicals – flows, consensus positioning and liquidity – are a risk to
any market. Contrary to popular belief, liquidity has not completely evaporated in high yield, however liquidity
is now concentrated in the hands of end investors which means it is more momentum driven (Charts 3 and 4).
Chart 3: Average daily trading volume of HY has
remained stable

1.4

Chart 4: Dealer inventories have been steadily
declining, but some respite in periods of volatility

22

% of market size

1.2

Dealer Inventories in Corp Bonds, US$bn

18

1.0
14
0.8
10

0.6
0.4

6

0.2

2

0.0
'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
12m Average Daily Trading Volume in HY

IG

-2
Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16
HY Dealer Inventories
IG

Source: Fidelity International, Deutsche Bank. Data as of 30 June 2016

Positioning: defensive, preferring US and Latin America
Through the summer, we plan to further reduce risk in the fund by rotating into higher quality names and
raising our cash cushion to the top of our typical 5-10% range. We entered the year with a credit beta of 115%
versus the benchmark (measured on a DTS basis) and lowered this to 103%. If spreads continue to grind
tighter over the traditionally slower summer months, we will use it as an opportunity to get more defensive,
taking credit beta down further, towards 90%. Our cash buffer will be used to raise DTS through the primary
market, where new issue premiums are still on offer, and the secondary market where volatility could give way
to attractive entry points.
In terms of regional positioning, we have rotated positions out of Asia HY where we find valuations too

stretched given the deterioration in balance sheets and less compelling technicals (Chart 5). Carrying on from
the end of last year, we continued to lower our allocation to the UK on the anticipation that the Brexit vote
could increase volatility and also took some profit in our European holdings recognising the rise of political
risks. Cash has been rotated into US HY to capture some of the stabilisation in commodity prices and Latin
America. The latter represents our largest regional change to date, due to its risk / reward outlook and high
conviction from our sovereign and credit analysts. Here we have added in capital goods, through names such
as Cemex and Eldorado, and consumer non-cyclical names via JBS, the Brazilian protein producer.
The Fidelity Global High Yield fund has delivered a double digit return this year, in line with its benchmark
(Chart 6). Given its ability to tactically allocate across the regions, we are able to take advantage of different
business and economic cycles. As a result, we expect a coupon clipping return for the remainder of the year
as, with yields above 6%, the asset class should remain underpinned.
Chart 5: Increasing allocation to US and Latin America
at the expense of Asia and Europe

70

Chart 6: FF Global High Yield has delivered consistent
returns since inception in 2012
12 Total return, %

Market weight, %

60

11.2 11.3

10

50
8

7.3
6.7

6.7

40

5.8

6

30

5.7

5.2

4.5 4.2

20

4

10

2

2.5 2.5

0
Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16
US

Europe ex UK

UK

LatAm

Asia

MENA

Source: Fidelity International, 30 June 2016. Regional allocation based on FF
Global High Yield.

0
1M

3M

YTD

Fund (gross)

1 YR

3YR

Since
inception

Benchmark

Source: Fidelity International, 29 July 2016. BofA ML Global High Yield
Index (HW0C). Performance based on gross paying A ACC Shares for FF
Global High Yield (SICAV). Basis Nav-Nav with gross income reinvested.
Annualised returns. Past performance is not a reliable indicator of future
results.

This information is for Investment Professionals only and should not be relied upon by private investors. It must not be reproduced or circulated
without prior permission.This communication is not directed at, and must not be acted upon by persons inside the United States and is otherwise only
directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. Fidelity
International refers to the group of companies which form the global investment management organisation that provides information on products and services
in designated jurisdictions outside of North America. Fidelity International does not offer investment advice based on individual circumstances. Any service,
security, investment, fund or product mentioned or outlined in this document may not be suitable for you and may not be available in your jurisdiction. It is your
responsibility to ensure that any service, security, investment, fund or product outlined is available in your jurisdiction before any approach is made to Fidelity
International. This document may not be reproduced or circulated without prior permission. Past performance is not a reliable indicator of future results. Unless
otherwise stated all products are provided by Fidelity International, and all views expressed are those of Fidelity International. Reference in this document to
specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors
should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. The research and analysis used in this
documentation is gathered by Fidelity for its use as an investment manager and may have already been acted upon for its own purposes. Fidelity, Fidelity
International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity Funds is an open-ended investment company established in
Luxembourg with different classes of shares. Reference to FF before a fund name refers to Fidelity Funds. Fidelity only offers information on products and
services and does not provide investment advice based on an individual's circumstances. The value of investments can go down as well as up and investors
may not get back the amount invested. For funds that invest in overseas markets, changes in currency exchange rates may affect the value of an
investment. Foreign exchange transactions may be effected on an arm's length basis by or through Fidelity companies from which a benefit may be derived by
such companies. Past performance is not a reliable indicator of future results. This document may not be reproduced or circulated without prior permission. No
statements or representations made in this document are legally binding on Fidelity or the recipient. Due to the greater possibility of default, an investment in
corporate bonds is generally less secure than an investment in Government bonds. Default risk is based on the issuer's ability to make interest payments and
to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers. Yields as at
30/06/2016 For an up-to-date yield please contact Fidelity. This is not a guaranteed yield. The value of shares may be adversely affected by insolvency or other
financial difficulties affecting any institution in which the Fund’s cash has been deposited. The value of bonds is influenced by movements in interest rates and
bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally
more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuer's ability to make interest
payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate
issuers.
Germany: Investments should be made on the basis of the current prospectus and/or the Key Investor Information Document (KIID), which is available along
with the current annual and semi-annual reports free of charge from FIL Investment Services GmbH, Postfach 200237, 60606 Frankfurt/Main or
www.fidelity.de. Issued by FIL Investment Services GmbH. Austria:Investments should be made on the basis of the current prospectus and/or the Key Investor
Information Document (KIID), which is available along with the current annual and semi-annual reports free of charge from FIL Investment Services GmbH,
Kastanienhöhe 1, D-61476 Kronberg im Taunus, Germany; as well as with the Austrian paying agent UniCredit Bank Austria AG, Vordere Zollamtstrasse 13,
A-1030 Wien, FIL (Luxembourg) S.A. – Zweigniederlassung Wien, Mariahilfer Strasse 36, 1070 Wien or www.fidelity.at. Switzerland: Investments should be
made on the basis of the current prospectus and KIID (key investor information document), which is available along with the current annual and semi-annual
reports free of charge from our distributors, from our European Service Centre in Luxembourg and from our legal representative and paying agent in
Switzerland: BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich. Issued by FIL Investment Switzerland AG,
authorised and regulated in Switzerland by the Swiss Financial Market Supervisory Authority. Italy:Please contact your financial advisor or the local branch of
your bank in Italy. Spain: For the purposes of distribution in Spain, Fidelity Funds, Fidelity Funds II, Fidelity Active Strategy and Fidelity Alpha Funds SICAV
are registered with the CNMV Register of Foreign Collective Investment Schemes under registration numbers 124, 317, 649 and 1298 respectively, where
complete information is available from Fidelity Funds, Fidelity Funds II, Fidelity Active Strategy SICAV and Fidelity Alpha Funds SICAV’s authorised
distributors. The purchase of or subscription for shares in Fidelity Funds, Fidelity Funds II, Fidelity Active Strategy and Fidelity Alpha Funds SICAV shall be
made on the basis of the Key Investor Information Document (KIID) that investors shall receive in advance. The Key Investor Information Document (KIID) is
available free of charge and for inspection at the offices of locally authorised distributors as well as at the CNMV. Portugal: In Portugal, Fidelity Funds are
registered with the CMVM and the legal documents can be obtained from locally authorised distributors. Nordic region:We recommend that you obtain detailed
information before taking any investment decision. Investments should be made on the basis of the current prospectus and KIID (key investor information
document), which is available along with the current annual and semi-annual reports free of charge from our distributors and our European Service Centre in
Luxembourg, FIL (Luxembourg) S.A. 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg. United Kingdom:Please note that not all funds in the SICAV fund
range are suitable for UK investors and tax advice should be sought before investing. Fidelity Funds are recognised under section 264 of the Financial Services
and Markets Act 2000 as amended by Rule 2(24) of the Undertakings for Collective Investment in Transferable Securities (UCITS) Regulations 2011. Investors
should note that loss caused by such recognised funds will not be covered by the provisions of the Financial Services Compensation Scheme (or by any similar
scheme in Luxembourg) if the fund is unable to meet its obligations, however claims for loss in regards to such recognised funds against a Financial Conduct
Authority-authorised firm such as Fidelity will be. The full prospectus and Key Investor Information Document (KIID) for these funds are available from Fidelity
on request by calling 0800 414 181. The UK distributor of Fidelity Funds is FIL Investments International. The Netherlands:Investments should be made on the
basis of the current prospectus and KIID (key investor information document), which is available along with the current annual and semi-annual reports free of
charge from our distributors, from our European Service Centre in Luxembourg, FIL (Luxembourg) S.A. 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg
(tel. 0800 – 022 47 09). In the Netherlands, documents are available from FIL (Luxembourg) S.A., Netherlands Branch (registered with the AFM), World Trade
Centre, Tower H, 6th Floor, Zuidplein 52, 1077 XV Amsterdam (tel. 0031 20 79 77 100). [Fidelity Funds/Fidelity Funds II] is authorised to offer participation
rights in the Netherlands pursuant to article 2:66 (3) in conjunction with article 2:71 and 2:72 Financial Supervision Act.
Belgium:We recommend that you obtain detailed information before taking any investment decision. Investments should be made on the basis of the current
Key Investor Information Document (KIID) and prospectus, which are available along with the current annual and semi-annual reports free of charge from our
distributors, from FIL (Luxembourg) S.A. and the financial service provider in Belgium, CACEIS België NV, with head office at Havenlaan 86C, B320, 1000 –
Brussels.Poland:This information is for Investment Professionals in the meaning of the Annex II to the Directive 2004/39/EC of the European Parliament and of
the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the
European Parliament and of the Council and repealing Council Directive 93/22/EEC only and should not be distributed to and relied upon by private investors.
This material does not constitute a recommendation within the meaning of the Regulation of the Polish Minister of Finance Regarding Information Constituting
Recommendations Concerning Financial Instruments or Issuers Thereof dated October 19, 2005. No statements or representations made in this document are
legally binding on Fidelity or the recipient and not constitute an offer within the meaning of the Polish Civil Code Act of 23 April 1964. We recommend that you
obtain detailed information before taking any investment decision. Investments should be made on the basis of the current prospectus, KIID (key investor
information document) and Additional Information for Investors, which is available along with the current annual and semi-annual reports free of charge from
our distributors, from our European Service Centre in Luxembourg FIL (Luxembourg) S.A. 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg and the
representative office in Poland. Hungary:Investments can only be made on the basis of the current prospectus/Key Investor Information Document (KIID),
which is available along with the current annual and semi-annual reports free of charge from our distributor Raifeisenbank Zentralbank Österreich AG,
Akademia u. 6, 1054 Budapest. The KIID is available in Hungarian language. Slovakia:Investments can only be made on the basis of the current
prospectus/Key Investor Information Document (KIID), which is available along with the current annual and semi-annual reports free of charge from our
European Service Centre in Luxembourg (FIL (Luxembourg) S.A., 2a, rue Albert Borschette, BP 2174, L-1021, Luxembourg) and from our paying agent
UniCredit Bank Slovakia, a.s., Sancova 1/A 81333, Slovakia. The KIID is available in Slovak language.
FIPM 1420


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