How big is too big?
According to one industry insider: “It’s a lot smaller than some of the large funds out there.”
The question of capacity cannot, however, be separated from the specific mandate a manager is tasked with. The broader the mandate and the less constrained the manager is, the less constrained their capacity will be.
“To have a fighting change of delivering alpha absolutely requires nimbleness and flexibility,” argues Fraser Lundie, co-head of credit at Hermes Fund Managers, who says other areas of the credit market, such as CDS, are less affected by issues like convexity and illiquidity. “People need to be aware of capacity constraints in high yield. So much mis-pricing is a result of money in inflexible mandates that are generally not fit for purpose,” he states.
The case for high yield looks increasingly stretched as inflows chase an increasingly capacity constrained sector, handing power to the sellers. The result has been a weakening of both bond covenants and potential returns to the detriment of investors.
Those with the ability to take a more selective view are better positioned to protect investors, but the overall demandside pressure on the market continues to suppress return potential even for those with less capital to employ. Simply following the flow could lead investors into dangerous water.
The advice handed out by Aon Hewitt’s Datta is very much ‘caveat emptor’. “The case for new high yield allocations is now fairly weak and if new investments are made, we would want to entrust high yield mandates to conservative managers with a high capability in security selection and risk monitoring, given that the emphasis in terms of return needs to focus on manager skill rather than market returns,” he says. “Though there are few immediate threats on the horizon in terms of a meaningful widening in spreads, the risks for high yield are increasing.”
Comments