FTAdviser.com

Advertising

There is no denying the Corporate Bond sector has suffered unprecedented falls in returns, but on top of this, the Resolution Asset Management £347.9m Corporate Bond fund has suffered more than most, remaining fourth quartile over three years against its peer group.

According to Morningstar, over one and three years, the fund has underperformed the IMA Sterling Corporate Bond sector by 10 percentage points, producing a loss of 21.2 per cent and 20.8 per cent, respectively, compared with a peer group average loss of 11.7 per cent and 10.7 per cent, respectively.

Chris Bowie, head of credit at Resolution and part of the team that works with lead manager Adam Walker on the fund, says he is frustrated at the extreme diversity in the peer group. "We are in a very diverse peer group. Some funds have a similar risk profile to this fund but others which, because of their mandate, cannot have long-dated bonds, high-risk, high-yield, financials. So although there are 76 funds in the sector, it’s not a like-for-like comparison. I have said for a long time that the sector needs to be carved up because there are far too many different types of objective within the universe."

He concedes that "significant exposure in AIG has hurt the fund" and says the extreme liquidity constraints in the market prevented the team from lowering its exposure to financials and asset-backed securities, "which has cost us in performance, no doubt". The fund has retained exposure to financials, with Standard Chartered, Old Mutual, Bank of Ireland and Citigroup all in the top 10, accounting for 7.5 per cent of the total portfolio.

Mr Bowie says: "Given how much financials and asset backed have been marked down, we now think the prospects for our fund are improving because we are very underweight cyclical and industrial names, and we think the focus seems to be moving from purely banks to cyclical exposure in the real economy. Our fund should perform relatively better."

He says corporate bonds have been particularly severely hit by the current crisis due to the combination of significant value erosion and illiquidity. Investment banks, which are the fund's usual trading partners, are now opting out of the market to preserve their own capital or offer prices at 20 per cent discounts to the bond bid price.

"That is a really big disincentive to trade because the yield on corporate bond funds tends to be 5-7 per cent, so it will cost 20 per cent in terms of capital loss just to trade. You have used up four years of yield just to sell a position when ultimately I don’t think the bond will default," he says.

In the topsy-turvy world bond traders operate in at present, Mr Bowie says, companies such as HBoS and RBS, which now have explicit government guarantees, are offering yields of more than 20 per cent - a "screaming buy" under usual circumstances - yet bid offer spreads remain vast. This has pushed the team's investment horizon from three to six months to a number of years, which in turn has heightened the strategic focus of the fund. Such a position is demonstrated by the fund's predominant allocation to five to 10-year dated bonds (38 per cent of the portfolio), compared with 21.8 per cent allocated to bonds maturing within five years, 23.1 per cent to 10-15 year bonds and 17.1 per cent to maturities longer than 15 years.

"There is a horrible scenario at the moment where we have faith in the company, we appreciate the value is being marked down but the cost of liquidating the trade would result in greater value destruction for the client than doing a short sell and buying it back in a year’s time," Mr Bowie says.

Instead, as bond mature and coupon income is returned, the team has kept those assets in cash or allocated to defensive areas such as sovereign wealth funds and supranaturals, which Mr Bowie describes as "quasi-government bonds that are counted as credit".

Like many in the corporate bond sector, this fund has struggled to reassure investors of the veracity of the credit breakdown in the portfolio - 80.3 per cent of the portfolio is investment grade, with the lower rating offered by Standard & Poor's and Moody's being applied. Mr Bowie is forthright in his view of credit rating agencies, saying "they have proven to be worthless" for Mr Bowie's needs, and that their business model allows a "conflict of interest". Referring to ratings within the structured credit market, he says, "I don't know how they can say an asset was AAA when it has lost 90 per cent of its value."

But Mr Bowie and team do their own analysis of companies and factor such data into an inhouse credit scoring model, so as to gauge for themselves the dependability of the rating agency standards. For example, Resolution has awarded RBS an A rating while the market still rates it AA.

That said, Mr Bowie has some sympathy for the agencies in that a financial crisis such as this can precipitate a company default, he says. For example, AAA rated General Electric has low leverage and strong earnings but a lot of short-dated debt. "It is hostage to what's going on in the markets," Mr Bowie says. "If it cannot roll over that short-dated debt, it could go bust, brought down by market events." A recent example of this is Northern Rock, he says.

While Mr Bowie is candid about the near-term prospects for corporate bonds. In 15 years' experience, he has "never seen it this bad". Although he believes all previous crises are dwarfed by the current turmoil, there is a silver lining: recession. He predicts a low inflation or deflation recession for the UK, an environment that would spark drastic interest rate cuts and bolster corporate bonds. With his own Isa savings now invested in this fund, its investors will be hoping future performance matches his strength of conviction.