Fixed income managers have said the Brexit vote could be a “nail in the coffin” for the sterling corporate bond market, predicting an acceleration in the decline of domestic issuance.
Managers have begun altering portfolios to reflect additional risk in the wake of the UK’s June 23 vote to leave the EU. A more significant consequence, however, could be a further drop in sterling issuance.
JPM Sterling Corporate Bond fund manager Andreas Michalitsianos predicted muted supply of sterling debt in future.
“We expect supply in sterling to be limited and opportunistic with market sentiment,” he said. “Economic uncertainty for the UK could hamper issuance in the domestic market and for UK issuers abroad.”
Adrian Hull, a fixed income specialist at Kames, said: “Sterling issuance has been higher, but for the previous five to 10 years it has seen a slower and lower run-rate [compared with dollar and euro issuance].
“I imagine the [Brexit vote] would exacerbate the decline. It would not be too apocalyptic, but it would not help and be a small nail in the coffin for the sterling-issued debt market.”
Sterling issuance had already dropped 31 per cent on last year as of June 20 as uncertainty rattled issuers, according to Mr Michalitsianos. By contrast, euro-denominated debt issues were up 20 per cent as the European Central Bank’s corporate bond buying encouraged issuers to come to market.
“The big draw [away from the sterling market] for global issuers has been the euro and dollar markets, where low yields and demand for high-grade corporate bonds has supported record levels of issuance,” he added.
However, TwentyFour Asset Management noted the post-Brexit shift towards defensives such as tobacco and consumer staples, evident in the equity market, had also given a fillip to sterling issuance.
“Brown Forman (makers of Jack Daniels) and British American Tobacco (makers of Lucky Strike, Rothmans amongst others), both issued sterling investment grade bonds [last week], and both deals went very well,” said manager Chris Bowie.
Change of tack?
Meanwhile Richard Woolnough, manager of the £14.5bn M&G Optimal Income fund, said the outlook for bonds had shifted following the vote.
Mr Woolnough has increased exposure to US assets such as Treasuries, and increased duration in his portfolio by one year.
“[The] Bank of England (BoE) will tolerate higher inflation and run a super-loose monetary policy and that means the outlook for bonds has changed,” he said.
“We have moved [duration] from being just below two years to just below three years. We’re still short and we still think that [inflation, interest rates and economic strength] matters. But it matters less.”
The manager said he preferred BBB-rated dollar and euro-denominated debt, but added he was not increasing credit risk.
The BofA ML Sterling Corporate index has returned 1.5 per cent since the referendum, partially tracking a rally in safe-haven gilts, but its high-yield counterpart has lost 1.8 per cent.
Credit’s struggles are not yet akin to those seen at the start of the year – spreads over government bonds stand at around 1.6 percentage points, compared with a 2016 high of 1.8 – but managers have been cutting risk.
Benchmark 10-year gilt yields have moved below 0.9 per cent for the first time ever in expectation that the BoE will have to ease policy in response to a Brexit-induced economic slowdown, a belief that was reinforced by a speech by governor Mark Carney last week.
Royal London Asset Management head of fixed income Jonathan Platt said the relative big winners from a Brexit decision, in credit terms, were supranational bond issuers, given uncertainties around the sterling market. He also said a shift to government bonds could be misguided in the medium term.
“We will look back and see the yields available now as a selling opportunity in government bonds. In the immediate aftermath, I don’t think there’s any rush to reduce exposure to [this asset class].”
Key numbers
£8bn
Sterling corporate bond issuance as of June 20, 31 per cent below 2015’s level
50bps
Fall in 10-year government bond yields in the two days after the vote to leave the EU
