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Rumours of the demise of energy bonds have been greatly exaggerated, says Kames Capital

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The energy sector is now offering investors some of the most attractive opportunities for years following the rapid decline in the price of oil, according to Kames Capital’s Phil Milburn.

While investors have been growing more and more bearish on energy bonds, warning the amount of issuance in the last year or so could cause a significant sell-off across the US and global high yield sectors, Milburn says the reality was many of the higher-rated companies have now sold-off too severely.
 
With just a tenth of the energy bonds in the Barclays Global High Yield Index rated CCC and below, Milburn believes many of the constituents in the single B space in particular look attractive on a long term view.
 
“The lowest-rated independent producers and the oil services companies are the most vulnerable, but rumours of the sector’s complete demise are greatly exaggerated,” he says. “There are now opportunities in the single B and above exploration and production companies, so we have selectively started averaging in.”
 
Milburn co-manages the Kames High Yield Bond Fund and the Kames High Yield Global Bond Fund alongside Claire McGuckin, with both funds top performers in their respective sectors. The former is ranked first quartile over one, five and ten years, and since launch in March 2002, while the latter is ranked first quartile over one, three and five years, as well as since launch in November 2007.
 
Milburn has been buying into a basket of energy bonds to mitigate risks and says: “We are taking a basket-based approach to adding to the sector.
 
“We make no claims of being able to call the bottom of the market, so we are keeping significant risk budget in reserve, but many of these companies’ bond instruments are already cheap and we believe buying some now will reward us in the long term.”

Even if the oil price was to stay below USD60 for an extended period, Milburn still feels the increase in defaults would be more than manageable.
 
“The contagion from such a scenario is easily containable, with realistic losses under a very draconian scenario still unlikely to be more than USD100bn,” he says.
 
With dispersion among issuers finally taking root, Milburn expects the sector can still deliver mid-single digit returns this year, with estimates of 5-8% realistic.
 
“While one should not get over-exuberant about the potential for mid to high single digit returns, I am pleased that there has been more dispersion in high yield bond returns since September, as it offers active managers like us the chance to add some alpha,” Milburn says.

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