Investors should expect a negative bond market reaction in the event of a Brexit vote, according to star manager Paul Read (pictured), co-head of Invesco Perpetual’s fixed interest team, who says the market is currently not pricing it as the likely scenario. 
The prospect of the UK opting to leave the European Union during the 23 June referendum, has raised concern among investors recently, most evident in the fall in sterling.
FE Alpha Manager Read, who manages a large number of portfolios totalling more than £25bn alongside co-head of fixed interest at Invesco Perpetual alongside Paul Causer, says Brexit is an increasing concern for bond markets.
“If you go to the betting shop now you will probably get 3 to 1 against, meaning there is probably a 30 per cent chance of a Brexit,” he said.
“When you take a step back and say what is priced into markets – about 20-25 per cent of the risk is currently priced into markets. The pound is already relatively weak. Sterling credit spreads have been under some pressure. Markets are dealing with quite a bit of risk off uncertainty this year in any case.”
Performance of sterling vs dollar in 2016
Source: FE Analytics
He added: “The risk is therefore appropriately priced in the markets at the moment but if it [Brexit] happens it is not a good thing.”
This is evident in a recent rally in lower rated corporate credits, where pockets of opportunity had opened up, Read adds.
According to FE Analytics, the IBOXX Sterling BBB Corporates All Maturities index has led the way in comparison to its more highly rated counterpart indices over the past month, as the graph below shows
Performance of indices over 1 month
Source: FE Analytics
“The credit market conditions have improved quite a bit in the last few week or month or so. But they are offering more opportunity than we have had for same time in a number of different areas, parts of high yield and parts of financials and parts of the corporate hybrid market,” he said.
The manager is particular favouring financials however, where he says the best ideas currently exist for attractive income streams.
This carries on a trend of favouring such credit for several years which, thanks to strong performance until recently, has fared well for Read and Causer.
Read’s funds have performed exceptionally well over the past seven years, according to data from FE Analytics. The manager has returned 118.01 per cent over seven years compared to just 72.06 per cent from his peer group composite.
Performance of manager vs peer group over 7yrs
Source: FE Analytics
The manager of the £2.45bn Jupiter Strategic Bond fund Ariel Bezalel, who is also an FE Alpha Manager, agrees that a Brexit vote is bad news for bond markets.
“I believe any immediate reaction to the UK voting to leave would be a weaker pound and weaker UK assets, since markets really dislike uncertainty. However, I am not convinced that the long-term economic impact would be particularly negative,” he said.
“In fact, the impact of a weaker pound could if anything provide a boost to UK exports. In addition, we don’t believe that many countries in Europe would simply stop trading with the UK if it opts to leave the EU.”
“My concerns about Brexit centre more around the political scene where the EU’s standing would be greatly diminished without the UK. In turn, the UK’s standing globally would likely be greatly diminished. “
Brexit, Bezalel adds, would also create greater political uncertainty in the UK and abroad as it increases the probability that David Cameron would step down as Prime Minister.
“We also believe that the UK leaving would create an existential question surrounding the future of the European project. In countries such as France, Poland and Spain, formerly fringe parties are making big headway in the European political scene.”
“A UK exit would in all likelihood increase the popularity of anti-establishment movements active across the continent. This, in our opinion, could create volatility across risk assets.”
As a result, the manager is positioning his fund to attempt to mitigate these risks caused by a potential Brexit.
“For much of February UK assets were under pressure as investors sentiment toward the UK turned negative on fears of a ‘Brexit’. Since then, we have seen something of a rally as risk has been back in vogue as investors have realised that UK corporates are generally in good shape.”
“It’s worth remembering that a benign interest rate picture combined with economic strength should enable many of the companies we own to pay down debt that bit quicker.”
Despite his concern the manager is retaining core allocation to the UK, which stands at 28 per cent, with banks making up around half our exposure.
“There are several reasons why we like the UK. Firstly, we believe that monetary policy is likely to remain loose for some time to come. In fact, the market currently expects no rate rise in the UK until late next year. Secondly, the UK economy is in relatively robust shape and has outperformed many of its peers globally.”
“Finally, we prefer UK banks to those in the eurozone because we believe they are, broadly speaking, the healthiest banks in Europe. This is crucial since the days when bondholders could expect to be bailed out in the event of a bank failure appear to be over. Tax payers have no more appetite to bail out bondholders, in our view.” 
“We suspect there could be more bond bail-ins over the next 12 to 24months, so avoiding unhealthy banks is crucial at this stage. The UK financials we like include the likes of Lloyds, RBS, Nationwide, Coventry and Barclays.”
Bezalel is also keeping almost a third of its assets in high-quality sovereigns such as the US and Australia, which he says tend to perform well on days when risk assets are weak.
“In addition, we currently hold about 2 per cent of the fund in gold mining convertibles which have performed well of late as gold is now being perceived as a safe haven asset.”
Another FE Alpha Manager, Richard Woolnough (pictured), who is the manager of the £14.95bn M&G Optimal Income fund, says Brexit is less of a concern than US presidential election.
“The likely impact on UK credit will be noise and uncertainty, but although Brexit fears are likely to cause volatility, a far more important political issue is the US election: investors should be less concerned with the EU referendum and focus more on the possibility of Donald Trump as US President,” he said.
