Current corporate credit environment is 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.

While most of his global government bond exposure is through macro strategies, he is bullish on paper from Ireland and Portugal, which he says is the fastest growing economy in Europe right now.

Mr Lanning, who is avoiding EM debt and reducing duration, is now finding renewed interest in absolute return strategies, such as those by Pioneer and remains bullish on convertibles like RWC’s for their additional ‘kicker’ to traditional bond strategies.

But while Mr Woolnough has also brought duration in his corporate bond books down as far as possible, Mr Jones believes shorting too far is not necessarily the solution.

“While we believe that gilt yields will get higher in due course, if interest rates go up you might find that the short-mid term maturities are impacted anyway.

“The longer maturities will be anchored by pension fund demand and the short won’t necessarily protect you in a rising rate environment.”

Sam Shaw is a freelance journalist

Fixed income outlook

Stephen Marsh, European head of fixed income at SEI, says:

“Overall, global growth is improving but below trend economic conditions are likely to persist, meaning interest rates are unlikely to rise any time soon. QE tapering in the US is likely to continue along a gradual path with little pressure to reduce significantly over the short to medium term.

“In spite of this, however, some volatility in fixed income markets are likely to remain as the market over- and under-reacts.”