One of the world's best high-yield bond investors is getting nervous about the riskier parts of the debt markets.
The Absalon Global High Yield fund, which beat 97% of its peers in 2017, isn't now "actively investing in CCC credits due to poor risk return characteristics."
"We're sort of late cycle," Klaus Blaabjerg, the chief portfolio manager, said in an interview Monday. "We don't like too much leverage."
High-yield bonds rose last year but doubts about the credit cycle and higher volatility have cooled the market in 2018. The Bloomberg Barclays Global High Yield Index has lost 0.5% so far this year, after a 10% return last year.
Mr. Blaabjerg, who oversees about 500 million euro ($600 million), predicts yield spreads will move sideways until the economic downturn hits, at least one year away.
"The late-cycle view that we have fits pretty well with our overweight of high quality," he said. "In fact, we have the highest average rating of the portfolio that we've ever had right now with an average rating of BB in the fund compared to B+ for the index."
The Hellerup, Denmark-based corporate credit team uses fundamental bottom-up analysis driven by valuations and is unconstrained without a focus on its benchmark. The fund returned 12% in 2017.
A "large exposure to rising star credits, credits moving towards investment grade from high yield or in some cases credits with investment grade ratings already" contributed to the performance, Blaabjerg said.
The fund is overweight financials. That's a sector that tends to perform well when interest rates rise, said Mr. Blaabjerg, who recently bought debt from Zurich Insurance Group.
Insurance companies "are really undervalued if you look at the spread and the underlying credit quality," he said. "The spread you earn on some of the banks in Europe are still pretty high compared with many non-financial credits."
The fund's top holdings are NIBC Bank, Jyske Bank, Gerdau Trade Inc., Nordex and UniCredit. The return year to date is 0.2%.
Mr. Blaabjerg and his partners Peter Dabros, Toke Hjortshoej and Sune Jensen prefer European and emerging markets credits to U.S. because those companies are more "conservative and less subject to disruption." But in emerging markets the team is underweight banks.
"Especially when it comes to those from China, we feel that you aren't paid enough spread for the underlying risk," he said. "We think it's prudent not to have it, really."