Fixed Income  

Current corporate credit environment is a ‘sweet spot’

This article is part of
Hunt for Income - March 2014

With strengthening economies and liquidity still pretty plentiful, the corporate credit market is presenting investors with a number of options, with Rathbones Unit Trust Management’s Bryn Jones describing the current environment as a ‘sweet spot’.

The fund manager and fixed income investment director says default likelihood tends to diminish when growth sits between 0-4 per cent, a view reflected in his £55m Strategic Bond fund.

This is through UK financials, mainly old-style subordinated debt issued by insurance companies and avoiding additional Tier 1, CoCos or hybrid corporate, believing the risks to be, for the most part, too high.

He adds: “I’m still a little nervous over high yield, because leverage is picking up, which is fine when rates are low.

“But if they start going up, then the interest expense increases, but if growth drops below zero then the companies won’t make enough to pay back their interest, and will default that way. This is all fine when leverage is low but when it picks up it squeezes that potential risk higher.”

JPMorgan Asset Management’s Tony Lanning, who runs the group’s £55m Fusion multi-manager range, remains exposed to high yield but expresses concerns over liquidity, given the strong run to date.

“We don’t believe high yield bond funds offer the fantastic value they once did. We agree with the view that corporate balance sheets are still in great shape and the risks are still very low but don’t want to get caught in a complacency trap. I worry about liquidity given the sheer amount of money that has gone into high yield, so I am keeping half an eye on it,” he says.

Cannacord Genuity’s global strategist Robert Jukes is also nervous of high yield although more for correlation reasons, preferring to use fixed income as a diversifier to equities in his multi-asset portfolios.

Currency risk is more of a concern and as such he is avoiding Treasuries, preferring UK gilts, and suggests that investors turning to Canadian, Australian and Norwegian bond holdings should heed caution. Meanwhile government bond yields are looking better value than 12 months ago, according to M&G Investments’ Richard Woolnough.

He spent the second half of 2013 adding duration incrementally across the group’s three flagship bond portfolios – Optimal Income, Strategic Corporate Bond and Corporate Bond – which together represent nearly £30bn of assets.

He warns that returns for investors in investment grade corporate bonds may calm down compared with recent years, but he still prefers it to government issuance.

“In 2014, we expect coupon clipping – rather than capital growth – to be the main driver of returns, much as it was in 2013.

“However, as we saw in January, when investors sought safety from the sell-off in risk assets, investment grade corporate bonds will do well in periods of risk aversion and equity market volatility.”

Elsewhere, Mr Jones has been adding emerging market exposure back into the fund, having sold out a year ago.