Investing in bonds is back on the radar as a spate of central banks across the globe brought an end to the era of rising interest rates before it truly got going.
Having initially planned to raise rates incrementally in 2019, the US Federal Reserve announced in March that it does not plan to raise rates for the rest of the year amid slower economic growth. It’s a move which has been echoed by others including the UK, which has its own cloud to manage in the shape of Brexit and, as a result, looks unlikely to raise rates until the end of 2019 at the earliest.
This, coupled with increased geopolitical uncertainty, means bonds have risen in popularity in recent months: figures from the Investment Association show fixed income has attracted almost £2.4bn of net retail sales in March and April. This compares to roughly £500m of net outflows from equities.
While strategic and global bond strategies have been the major contributors to those net flows, I wanted to take a look at the corporate bond sector, which finally saw inflows for the first time in six months in April 2019.
Corporate bonds have not been popular for some time and there are concerns that the volume of BBB-rated bonds - the lowest level of investment grade that still meets investment grade requirements - has more than doubled recently. The size of the market, increasing leverage and the potential for downgrades, has prompted the Bank of England to warn that a sudden downgrade of corporate bonds, as seen in 2002 or 2008, could cause chaos in markets.
Naturally, this is something investors cannot ignore, but corporate bonds do offer diversification to investors over the long-term and, while volumes of BBB bonds are a concern, active management can help navigate those concerns to a great degree. Below are three active managers we like in the corporate bond market.
Royal London Corporate Bond fund
This fund is different to many of its peers due to the manager's ability to identify less well-known bonds with superior risk-adjusted returns.
Jonathan Platt believes there is an over-reliance on the likes of ratings agencies and that inadequate benchmark construction methods lead to inefficiencies that a stock-picking manager can exploit. He pays particular attention to the asset-backed sector and unrated bonds. In addition to credit quality analysis carried out by most bond fund managers, Platt goes into painstaking detail, analysing covenant documents to estimate not only the chance of default, but the expected recovery rate too.
This focus on less researched areas of the market is supported by having a diversified portfolio of around 200 names. The fund has returned 32 per cent over the past five years to 24 June, compared with 25.6 per cent for the sector average. It also has a distribution yield of 3.76 per cent as at 30 April.
TwentyFour Corporate Bond
This fund is constructed using a total return mindset, rather than just focusing on making the most income possible. Manager Chris Bowie will have a mixture of around 80 per cent investment grade and 20 per cent high yield or floating rate notes at any one time. Within the investment grade section, there will be a strong weight to gilts and supranationals (such as the EU or the World Trade Organisation).
To find his holdings, Bowie uses the firms’ bespoke quant research tool Observatory. The fund will only hold a maximum of 100 stocks at any one time. The process focuses on total returns, meaning Bowie isn't sacrificing growth to artificially boost the yield, nor is he taking part in high-risk growth ideas. These stocks will all be public, and will all have ratings from one of the main agencies.
Returning 20 per cent since launch on 15 January 2015 to 24 June 2019 compared with 16.7 per cent for the sector average, and we feel it is one of the most dependable corporate bond funds out there. It has a yield of 3.14 per cent, as at 31 May.
BlackRock UK Corporate Bond
Ben Edwards has a proven track record of consistently exploiting inefficiencies in the fixed income market. While the majority of bonds will be investment grade with relatively high credit ratings, the manager has the ability to source other ideas from asset backed securities, high yield and unrated bonds and those denominated in euros and US dollars (although these will be hedged back to sterling).
For the best alpha opportunities, Edwards has a sweet spot of bonds that are rated BBB to BB, and which are five to 10 years from maturity. That being said, the flexible, unconstrained mandate does mean he can position the fund to where he believes the best opportunities are and will often avoid index stalwarts if he does not see the potential for alpha to be made from them.
The fund yields 2.62 per cent and has returned 30.6 per cent in the past five years to 24 June, compared to an average 25.6 per cent for the sector.
Darius McDermott is managing director at FundCalibre. The views expressed above are his own and should not be taken as investment advice.