Fixed Income  

M&G’s Russell backs Carney on rates

M&G Investments’ Matt Russell has played down criticism of Bank of England governor Mark Carney following criticism of his perceived U-turn on forward guidance.

When he succeeded Sir Mervyn King as head of the Bank last summer Mr Carney said if the UK’s unemployment rate fell to 7 per cent it would give cause for the monetary policy committee to reassess its ultra-low interest rate policy.

But last month when data showed this 7 per cent trigger point was close to being reached, Mr Carney downplayed its importance and emphasised that rates would stay at 0.5 per cent for at least the rest of 2014.

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Mr Russell said: “When we look back on this period I think we will believe Mark Carney did the right thing. The economy is improving so he is giving confidence to businesses and the population to be happier spending a bit of money. This feels more like the economic recovery coming through, not worrying about asset prices.”

Mr Russell, manager of the £391m M&G Short Dated Corporate Bond fund, also argued for a more positive outlook for corporate bonds in the face of heightened fears of a major bear market in the asset class as the US continues its QE tapering.

He said there was potential for price increases in euro and sterling-denominated bonds in spite of these assets trading close to government bonds. Mr Russell said spreads – the difference between corporate bond yields and their respective government yields – were more likely to tighten from current levels based on historical data. When spreads tighten, yields move down and prices rise.

“Credit isn’t as cheap as it has been but we are unlikely to see a repeat of the historical peak,” he said, referring to the massive selloff in 2008 and 2009.

Mr Russell added that “it feels like we are being overcompensated” for the likelihood of the fund’s holdings going bust, known as the default rate.

Part of a bond’s yield comprises of a ‘risk premium’ based on the fact that higher yielding companies are more likely to collapse, and Mr Russell said this was currently implying that 12 per cent of companies were at risk of going bust - far above the long-term average.

The manager is specifically focusing on subordinated bank debt from “strong money centre banks”, buying bonds which pay out higher yields because they are paid out later in the event of a default.

He said he was “happy that these banks are doing better and going to survive”, meaning his fund can benefit from a higher coupon payment.

In addition, subordinated debt is often issued as callable bonds, which either repay an investor’s capital after a set period or are converted to floating rate bonds, which then pay a coupon that rises with interest rates.

Mr Russell holds 15-16 per cent of the fund in mortgage-backed securities that will also increase coupons when interest rates rise, giving a degree of protection against the losses conventional bonds are likely to incur.