Fixed IncomeMay 18 2016

Fidelity bond duo shun Scottish issuance over Brexit fears

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Fidelity bond duo shun Scottish issuance over Brexit fears

Fidelity managers Ian Spreadbury and Sajiv Vaid have declined to participate in a Scottish company’s bond issue for fear of the knock-on impact of the UK’s referendum on EU membership.

The managers, who run a range of fixed income portfolios at the fund group, said their investment strategy retained a “focus on safety” because of the possibility that systemic risks – such as rising global debt levels – could prompt further volatility.

These concerns have been amplified by the presence of short-term uncertainties such as the EU referendum, an event which Mr Vaid said had contributed to “disappointing” levels of sterling-based issuance at the start of the year.

However, one bond that did come to market was sidestepped by Mr Vaid and Mr Spreadbury. The pair said they declined to participate in 10-year bond issuance from energy distributor Scotland Gas Networks because of the risk that a vote to leave the EU would prompt a fresh drive for independence in Scotland.

Scottish corporates came under pressure ahead of the 2014 independence referendum as investors fretted over the impact of independence on the country’s fiscal position.

“Because of Brexit issues and the knock-on effect that may have on the Scottish referendum, we didn’t feel we were adequately compensated despite [the bond] being well priced,” Mr Spreadbury said.

The manager, whose funds include Fidelity Strategic Bond, Extra Income and Moneybuilder Income, said he did not expect a Brexit to occur, but maintained his portfolios were in a “reasonable position” in such a scenario.

“The sectors that would be hurt more would be financials, particularly the banks, and also anything property related. I think we’re not overly exposed.”

But Mr Spreadbury and Mr Vaid continue to favour one type of financial debt: covered bonds, which typically use mortgages as collateral to be reclaimed by an investor in the event of a default.

“We are in a world of bail-ins, and covered bonds are exempt from haircutting,” Mr Vaid said.

He added the £3.4bn Moneybuilder Income fund had also upped its exposure to asset-backed securities in the past year, but said the vehicle had kept a bias to non-cyclical sectors, such as tobacco and utilities.

Mr Spreadbury said: “I feel systemic risk is quite high given the structural debt in the global economy. I think we’ll see volatility going forward.”

But despite global growth concerns having reduced the likelihood of tighter central bank policy in the near future, the manager said he was alive to the risk of further interest rate rises.

“I feel that if [the Fed] gets another chance, if the economy does see a modest pick-up, we will see further hikes. But any hike will be quite modest,” he said.

The managers continue to see value in credit markets despite their cautious stance.

“Spreads have tightened a little bit, but historically [investment-grade] credit is still at quite attractive levels,” Mr Spreadbury said.

Opportunities in the sterling-based market have been relatively limited so far this year.

Dealogic data shows sterling investment-grade bond issuance for the first three months of 2016 fell to an 11-year low of £2.4bn. But Mr Vaid was confident the shortfall was only a blip.

“Further issuance will be held back until we get over the referendum. Subsequently I think you will see a lot more issuance pick up,” he said.

Key numbers

53%: Year-on-year fall in sterling investment grade issuance in the first quarter

£3.4bn: Size of Fidelity Moneybuilder Income fund