“So it’s not a government bond or a cash versus high yield choice that investors are making, it’s ‘If I have a dollar of risk capital that I’d otherwise put to equities, then I may be better at this point putting it into a credit-based investment because of the risk premium’, bearing in mind the risk premium in sub-investment grade has contracted quite a lot in the last two months.” A rising default cycle is the key risk to any credit portfolio in the current environment, with default rates sitting well below previous cycles and widely expected to rise further.

John Wilson, chief executive officer of PIMCO Australia, says despite the “enormous amount of talk” about opportunistic credit, very little money has actually gone into the sector. “The spreads are very wide and they are wide for a good reason,” he says. “We are at the start of the default cycle, not the end of it, and the evidence for that is in the big bank’s results… you’re seeing a crisis of funding now with the airlines, you’ll see more corporates that do real things come out looking for capital over the next couple of years and be unable to find it, and no bank lines available to them.” He adds: “You’re crazy to be talking about opportunistic credit like it’s a beta play; you’re going to need extremely careful stock selection.”

Coupled with this is the concern that recovery rates on defaulted bonds will fall well below the traditional average. According to Mercer’s Wang, recovery rates on corporate bonds typically average around 40 per cent; in this cycle, single digits are within the realm of possibility. Similarly on bank loans, the average recovery rate has dropped from about 70 cents in the dollar to around 30 to 40 cents this cycle. However US-based manager Nicholas Applegate is confident default rates will not rise to the level that current spreads are implying, creating a total return opportunity in the high yield market.

Greater market diversification; more issuers with cash flow to support balance sheets; and refinancing over recent years, which has created lower interest expense obligations and extended maturities, indicate default rates in the high yield market are unlikely to surpass past cycles, argues Douglas G. Forsyth, portfolio manager, income & growth strategies. “In December 1999 leading into the defaults that occurred over the next two years, 42 per cent of the market was made up of technology, media and telecommunications issuers,” he says. “There is no industry concentration to that level in March 2009.