Fixed income managers have started circling bonds issued by embattled supermarket Tesco as the business seeks to overhaul itself.
John Anderson has made a Tesco bond the top holding in his Smith & Williamson fund, while fixed income specialist TwentyFour Asset Management is eyeing the grocer’s debt too.
Mr Anderson said a Tesco bond, which matures in 2036, was now the largest holding in his £29m Fixed Interest Trust at 4.3 per cent.
The portfolio had exposure to Tesco before the manager took the fund on in July last year, but he has added to the position because it was “ridiculously cheap”.
At TwentyFour, fund manager Chris Bowie said the Tesco bonds now yield twice what Marks & Spencer does, representing “the best risk/reward entry point for a Tesco trade that we have ever seen”.
In September last year, when it was revealed Tesco had overstated its profits, Mr Bowie was wary of the bonds on the view their prices could fall further.
Since the accounting issues were made public, Tesco’s senior unsecured long-term rating has been downgraded by Moody’s Investors Service from Baa3 to Ba1. This moves the supermarket from investment grade to non-investment grade or ‘junk’ status.
But in spite of this, Mr Bowie suggested there was now an opportunity emerging.
“It is likely S&P will follow suit, and if both ratings agencies have the bonds rated high yield, there will be a risk of forced selling from pension funds and life company mandates, which forbid high-yield investments,” Mr Bowie said.
“The pace and scale of this impact is hard to predict, but… we would argue that the majority of this risk is already in the price.”
New Tesco chief executive Dave Lewis has now announced his plans to overhaul Tesco, which include cost-cutting measures, staff redundancies and the sale of assets such as Tesco Bank.
Mr Anderson said now this information was in the market, the bonds were attractive.
“The bonds are pricing as if Tesco is going bust and that’s ridiculous,” he added.
Even though the manager’s process is to stick to investment-grade debt, he is holding on to the bonds because of their potential.
Mr Anderson was also hoping to buy the bonds of one of Tesco’s rivals, Morrisons, after it announced on January 13 its chief executive Dalton Philips would step down.
However, to his surprise, the bonds rallied.
“Markets didn’t respond as expected,” he said.
“Arguably Tesco’s results were a bit better than Morrisons’, but the markets don’t reflect that.”
