Capital Ideas^TM

Most investors will broadly understand the benefits of combining assets with different attributes to reduce risk – but diversification can also be a key part of generating a consistent high income from an investment portfolio.

Capital Group UK – Global High Income Opportunities, which launched for UK investors on 18 January 2023, is designed to capitalise on two key routes to unlocking higher income from bonds.

First is diversification by country. Rising political and economic risk have created a challenging backdrop for UK investors, so greater exposure to global assets could help provide more consistent income. Markets may also be at different stages through the investment cycle: having been burnt by inflation in previous decades, for example, many emerging market central banks have been ahead of developed market counterparts when hiking interest rates in the aftermath of the pandemic.

By allocating away from the domestic market, UK investors could not only capture these opportunities but also achieve better diversification. 

Building on this, a second way to unlock income is by combining asset classes in the fixed income spectrum. Capital Group UK - Global High Income Opportunities – which includes two of the highest-yielding bond markets, emerging market debt (EMD) and high yield bonds – could not only help increase the income available but could also amplify diversification benefits without taking on excessive additional risk.

As evidence, Capital Group’s Global High Income Opportunities strategy¹ on which the UK fund is based, has consistently produced superior long-term returns compared with three underlying asset classes: high yield bonds, EMD local currency and EMD hard currency. Over the period from January 2003 to the end of 2022 the strategy’s annualised return is 7.9%², compared with 7.3%³ from high yield corporate bonds, 6.3%⁴ from EM hard currency debt and 4.9%⁵ from EM local currency.  

For UK investors still cautious about moving into different parts off the bond market, some myth busting is useful. While high yield bonds and emerging market debt may carry a higher risk than investment grade bonds, a number of misconceptions surrounding these asset classes remain.

High yield bonds were previously known as junk bonds because companies issuing this debt were typically lower quality and carried greater risk of default. Today, the high yield market is largely made up of listed mid- and large-cap companies, and 88%⁶ of the US high yield index is rated ‘B’ and above (the portion of the universe that typically has the lowest default risk).

With a full market value of US$1.6 trillion, it is approximately three times the size of the combined value of the UK sterling investment grade and high yield markets.⁷ Issuing debt in this space is seen as a permanent and normal way of financing and represents an efficient overall blended ‘cost of capital’ for many companies.

As for EMD, the perception is that these markets are higher risk with a significant chance of default; in fact, many emerging economies have lower government debt-to-GDP ratios than advanced peers, as well as lower levels of corporate and consumer debt.

Emerging market creditworthiness has also improved as they have moved towards flexible exchange rates, foreign exchange reserve accumulation, lower external deficits, and local currency debt issuance. Around 75% of local currency sovereign bonds are investment grade, while hard currency sovereign bonds have an average credit rating of BB+ (the highest credit rating for high yield bonds).⁸

When it comes to high yield and EMD, risks may remain higher than investment grade, but many characterisations of these markets have not kept pace with the considerable market maturation that has occurred over the past 30 years. 

We continue to believe the wider choice of assets used within Capital Group UK – Global High Income Opportunities – and diversifying within these areas – may help to increase the portfolio’s capacity to deliver higher income and total returns.

 

Capital Group Global High Income Opportunities strategy

 

Past results are not a guarantee of future results. Invested capital is at risk; the fund aims to achieve a positive return over the long term although there is no guarantee this will be achieved over that or any time period.

 

1.  The Luxembourg SICAV Capital Group Global High Income Opportunities (LUX) (inception: 7 May 1999) is referenced as a representative account for the strategy. This is intended to illustrate our experience and capability in managing this strategy over the long term.

2. Returns for a representative account for the strategy are before fees and expenses in US$ terms. Due to the availability of data for the emerging market local currency debt index (JPMorgan GBI-EM Global Diversified Total Return), we have shown all returns since its inception on 31 December 2002, to ensure consistency when comparing one asset class with another.

3. Bloomberg US Corp High Yield 2% Issuer Cap Total Return Index. Returns in US$ terms. Source: Bloomberg

4. JPMorgan EMBI Global Index. Returns in US$ terms. Source: JPMorgan

5. JPMorgan GBI-EM Global Diversified Index. Returns in US$ terms. Source: JPMorgan

6. As at 31 October 2022. Bloomberg US High Yield 2% Issuer Cap Index. Sources: Capital Group, Bloomberg, JPMorgan. Ratings based on the higher rating of S&P, Moody’s & Fitch for the highest weighted issue.

7. As at 30 November 2022.  Bloomberg US High Yield – 2% Issuer Cap Index compared with Bloomberg ICE BofA Sterling Corporate Index, ICE BofA High Yield Index and ICE BofA Sterling High Yield Index. Sources: Capital Group, Bloomberg, JPMorgan

8. As at 30 September 2022. Emerging market local currency sovereign bonds represented by JPMorgan GBI-EM Global Diversified Total Return Index. Emerging market hard currency sovereign bonds represented by JPMorgan EMBI Global Diversified Index. Using BlackRock Aladdin analytics. Higher rating of S&P, Moody’s and Fitch.

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• The Prospectus – together with any locally-required offering documentation – set out risks, which, depending on the fund, may include risks associated with investing in fixed income, derivatives, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.