The US Federal Reserve is unlikely to act as aggressively as many investors fear this year, according to Canada Life Investment’s Bill Harer and Michael Count, who also believe the European Central Bank (ECB) is too focused on generating growth to hike interest rates.
The managers of the CF Canlife Corporate Bond fund also point out that inflation could well peak during the first half of this year and, as such, aren’t overly concerned that it will exceed market expectations and eat into the value of coupons.
The pair remain sanguine on the prospects for investment-grade credit as we head through 2017 and believe spreads will remain stable and move sideways.
“Yes, [spreads] are quite tight if you view them from post-crisis history, but obviously that’s benchmarking yourself against the widest spreads ever seen,” Count said.
Performance of indices since 2008
Source: FE Analytics
“It’s still wider than where we were pre-crisis; although the Bank of England programme might wrap up fairly soon – it was quite small – you still have the ECB continuing to buy corporate bonds for the remainder of this year so we think spreads will go sideways.”
Many investors have become cautious on bonds generally during recent months, due to concerns that rising inflation will impact purchasing power and therefore the value of their investment in real terms. The other major concern is whether interest rates will rise, which would of course have a negative impact on the price of bonds as new issuers offer higher yields.
However, Harer and Count don’t believe the 35-year bond bull market is over yet and, despite many industry commentators predicting fiscal expansion, rate rises and an uptick in inflation this year, believe there is still demand for fixed income.
“One of the things that is happening is that bonds are taking a long time to die,” Harer - who is also head of credit research at Canada Life Investments - said. “One of the reasons for that is people are looking around and wondering where else they put their money. Obviously, there are low cash rates but other markets look quite pricey as well.
“As an aside, I think diversification is one of the reasons why you would still hold some bonds. Over here and in the eurozone, [central banks] are also in no hurry to raise rates. What are these monetary rate-setting committees afraid of being blamed for? What is the eurozone afraid of being blamed for?
“They’ve spent years trying to get the eurozone economy going and the last thing they want to do is kill that off, as we have seen happen in Japan on a number of occasions. The ECB is in no hurry to tighten and, in the UK, again, they’re in no hurry to tighten.”
One market many investors are expecting to implement fiscal policy is the US, following the election of Donald Trump last year. As such, many investors are expecting the Fed to continue to hike rates, with Yellen herself predicting three hikes throughout 2017. Since the day of the 2016 US election, in fact, US investment-grade corporates are down 0.42 per cent in sterling terms while the S&P 500 index is up 10.66 per cent.
Performance of indices since 2016 US election
Source: FE Analytics
“I think people see the Fed as being very aggressive but I don’t think it is going to be quite as aggressive as they think, because they have taken steps now and will want to give it a bit of time,” Harer reasoned.
In terms of the fund’s positioning, the managers are seeing attractive opportunities within the UK consumer discretionary sector, given it struggled during the immediate aftermath of the EU referendum and remains somewhat unloved compared to other areas of the market.
“We like pubs and have done since the referendum, particularly,” Count said. “Although we think there will probably be a negative knock to growth, our view was that pessimism was overdone and particularly in the near term. We may be in the process of leaving but we’re still part of the EU. It was definitely too pessimistic.
“Within UK consumer-facing retail, pubs are a good example of businesses that are dependent on discretionary spending. In our view the sentiment has become far too negative in this market area. We have held onto that position and added as well.”
While some investors are negative on the consumer discretionary sector due to rising inflation and the impact this could have on spending power, the duo believes UK consumers are resilient.
“Within the UK economy, we’re hopefully undergoing a transition away from consuming to manufacturing and producing; that can include making Jaguars but it can also be services that people want to buy as well. I think that’s a much healthier emphasis,” Harer continued.
“Real incomes at the moment are flat because wages and inflation are running at roughly the same rate, so that is going to put a bit of a dent in the consumer.
“But, I think the British consumer has an unquenchable thirst for products, so that is still going to be a reasonably solid engine room. But hopefully we will see more of a switch.
“It’s great that surveys are looking very positive for the manufacturing of services and exports; that’s exactly the kind of transition we need to be making. But in terms of the outright level of inflation, there have been some fairly wild predictions that inflation is going to be in excess of 4 per cent. I don’t think we’re seeing that in the numbers.”
Since Harer and Count have co-managed the £298m CF Canlife Corporate Bond fund, it has returned 34.08 per cent, which is broadly in-line with the performance of its average peer.
Performance of fund vs sector under Harer and Count
Source: FE Analytics
If an investor had placed £10,000 into the fund at the start of their tenure, they would have received £1,776.32 in income alone.
The fund has a clean ongoing charges figure of 0.57 per cent and yields 3.75 per cent.