Kames High Yield Bond manager Philip Milburn does not expect Cyprus on its own to derail the eurozone but is remaining wary on peripheral sovereign risk.

Speaking on the 22nd March, Milburn told Citywire Global that while Cypriot bank depositors under the guarantee level would be exempt, those over the deposit limit of £100,000 were unsecured lenders and therefore ‘fair game’ if Cypriot banks went bust.

But he believes that the existence of so many overseas investors and in this case predominantly Russians, will be of some help to the Cypriot government.

‘Overseas investors give domestic governments a way of externalising part of the cost of any bailout, he said.

Wary of CCC bond risk

But Milburn remains cautious overall on the eurozone adding: ‘[ECB chief] Draghi may have solved liquidity problems but fundamental issues over solvency remain'

He thinks high yield bonds are still offering fair value but accepts that yields are ‘pretty low’ and the fund remains in capital preservation mode.

He is keeping his allocation to CCC–rated bonds down at just 5% of the fund as he believes the macro backdrop does not justify a more punchy weighting.

The fund also has very little in peripheral Europe with around 2% in Italy through bottle top business Guala Closures and a further 0.5% in Irish packaging firm Ardagh, but he points out that the latter has just 0.5% of its operations in Ireland.

Milburn told Citywire Global: ‘This is not a time to be taking on extra credit risk and I don’t think you are getting compensated for generic triple C risk.

‘Default rates increase exponentially when you go down the ratings bands and although default rates are likely to stay low by historic standards they will not be zero. The mark- to –market volatility of CCC rated credit is significantly larger than in better rated bonds.’

Milburn added that if the lower rated segments of the market rallied he and co- manager Melanie Mitchell would reduce risk even further.

He is happy not to chase the highest yielding CCC-rated bond, arguing that he would rather ‘sacrifice a little upside to avoid a more serious downside’ if the market does turn.

But he added: ‘If there is a market sell-off we will look to tactically increase the fund’s risk from its defensive base. We took our foot off the gas a little early but are trying to manage risk through the market cycle.’

With the fund predominantly in BB and B rated companies, Milburn continues to be heavily underweight banks, which make up just over 4% of the portfolio, while just under 60% is in industrials.

Around one quarter of the fund is invested in companies in the TMT sector with the risk spread across a wide range of countries.

Germany’s Unity Media is the largest holding while Milburn also has stakes in a Swedish cable firm, as well as US fixed line operator Windstream and the country’s third biggest mobile operator Sprint.

The fund also has holdings in US satellite provider Intelsat and US cable TV giant Dish, as Israel’s Hot Telecom.

‘We like the recurring revenues and the strong subscriber base [these companies] have.'

Milburn has recently been increasing exposure to utilities firms which he describes as ‘dull but offering steady returns.’

Debt in transmission masts business Arquiva has been added, along with a bond in water utility Kelda.

‘We are happy to move down the capital structure in utilities because we get steady if dull returns. Kelda is trading at around 5.5%.’

The fund has seen net inflows of around £800 (€943) million over the past year and Milburn revealed that the strategy could be workable up to a limit of £5 billion.

‘That would be £2 billion for the UK fund, £2 billion for the Dublin fund and £1 billion for segregated mandates.'

Upping dollar exposure

Milburn is encouraged by the relatively stronger performance of the US housing market over the past year and has been upping exposure to the dollar.

After hedges, the fund has 55% of its assets exposed to the US dollar and around 20% exposed to the euro.

Kames announced on 25th March that it was launching a Singapore share class for the fund.

Over the five years to the end of February, the fund has returned 77.3% against the 91.9% posted by the BofA Merrill Lynch Eur Currency HY Const benchmark.

Citywire Selection Verdict: This fund positions itself very much at the defensive end of the high yield bond market, investing in the quality end of the spectrum. Returns have been impressive in recent years as the market has boomed, while not keeping pace with the index it has remained competitive with its peers and long-term Philip Milburn is still the best high yield manager available in the UK. The manager feels the good times are at an end for high yield, but isn’t overly concerned about the downside, believing instead that gains will be moderate for the coming years. The fund can still serve as a good diversifier.