John Pattullo has ramped up his exposure to insurance company bonds as he expects they will benefit from new regulatory pressures on the sector.
The head of retail fixed income at Henderson Global Investors said he had been targeting the bonds of insurance companies and had recently increased the weighting in his £1.2bn Strategic Bond fund to 20 per cent.
In the third quarter of last year, the manager held 30 per cent in bank and insurance bonds combined, but now holds 20 per cent in each.
Mr Pattullo said he expected 2016’s Solvency II rules – a European directive aimed at making sure insurance companies have sufficiently stable finances – to be a driver for fixed income securities linked to the industry.
He has made this prediction because he expects insurance companies will soon begin buying bonds back from investors so they can cancel them and then issue new types of debt.
A similar thing is already happening in the banking industry.
European and UK legislators have been stress-testing bank balance sheets and have implemented new requirements on how much capital banks need to have against their liabilities.
Several banks have already started buying up their ‘old-style’ bonds and have begun issuing contingent convertible bonds, known as cocos.
Unlike standard bonds, these bonds count towards the new capital requirements as they can be converted into equity based on pre-agreed terms.
Mr Pattullo had already been targeting bank bonds because of the trend of banks offering to buy back the old bonds at their par value, and has now been boosting his exposure to insurance company bonds.
“With Solvency II, insurers will be better capitalised and they will have legacy issues just like the banks do, and that becomes a good thing for bondholders,” Mr Pattullo said.
The manager said two of the fund’s top-10 holdings were insurance company bonds, including issuances from Legal & General Group and Prudential, which each made up 1.7 per cent of his Strategic Bond fund.
Elsewhere, Mr Pattullo said cash in the fund had reached 10 per cent, which was at the upper end of what he liked to hold in the asset.
He said roughly 8 per cent of his portfolio had matured, meaning cash was returned to him from the businesses he had lent it to.
One of these bonds belonged to Alliance Boots, which owns high street chemist Boots. The company is set to merge with American firm Walgreens in February, with the merged entity to be named Walgreens Boots Alliance.
Because of the merger, which was confirmed at a December shareholder vote, Alliance Boots ‘called-in’ the bond, which means it paid investors back their capital before the bond matured.
The Strategic Bond fund has delivered top-quartile returns in the past 10 years and has produced second-quartile returns in the past one- and three-year periods, according to data from FE Analytics.
The manager said this year he would be targeting a yield of 6.5-7 per cent – the same figure as in 2014.
Cocos are under the watchful eye of the regulator
Investors have been encouraged to buy up new types of debt issued by banks – particularly contingent convertibles, known as cocos.
These new-style bonds have become popular as they can usually be converted into equity, which can help the issuing bank in a crisis.
They also help the banks reach the levels of capital they need to comply with new restrictions aimed at making banks more resilient because they can be treated differently in the accounting process to plain vanilla bonds.
Banks issuing this new type of debt have more often than not attached a higher yield to these bonds than their conventional debt.
But the bonds are being watched closely by the FCA, which in October moved to make its temporary restrictions on the specialised form of banking corporate debt permanent and widen the parameters to include some funds.
The regulator said at the time the ban would extend to funds that “invest wholly or predominantly in cocos and which are not retail-oriented regulated funds”.
