Fixed Income  

RLAM’s Holt: Rating agencies are misreading markets

RLAM’s Holt: Rating agencies are misreading markets

Credit rating agencies’ mistakes are leaving room for exploitation in the competitive credit market, according to Eric Holt.

The manager of the £1bn Royal London Sterling Extra Yield Bond fund said ratings agencies’ focus on the probability of a firm’s default – rather than its likelihood of recovery – is skewing their outlooks on corporate debt.

Mr Holt, who also sees opportunities in off-index bets (given a minimum issuance of £250m is required to be included in investment-grade indices), said ratings agencies are operating with a “dead hand”.

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An example used by Mr Holt is Annington, a real estate firm that accounts for 1.7 per cent of his portfolio as of August 31.

The company’s bonds are CCC-rated due to what Mr Holt described as a “dodgy way of analysis”. The firm offers subordinated bonds on a payment-in-kind method, meaning cash payments can be received by the bondholder in the form of senior bonds.

This payment-in-kind method has prompted agencies to give the debt a lower credit rating. But, according to Mr Holt, the fund is receiving £120 market worth of senior bonds for every expected £100 cash payment.

These discrepancies help make the corporate bond market relatively cheap compared to gilts, the manager said. Bondholders are being “well paid for incremental risk that should deliver incremental returns over the medium term”.

Mr Holt also suggested investors are overvaluing liquidity, saying they “need to make sure they are not paying for it or relying on it too heavily”.

While admitting there is not the “depth of liquidity as there was pre-credit crunch”, and this did increase volatility, he remains bullish on his ability to manage this issue.

“There is an art in managing liquidity within a portfolio. [Liquidity] is affecting cashflows, but it is about communicating with investors so they understand what the influences on performance are,” he said.

Turning to a macro view, Mr Holt said recent economic figures have been “incredible” but said the UK is still on the road to recovery – indicating interest rates are not about to rise.

“Expectations are volatile, but over the medium term rates will stay low. [The fund’s] positioning isn’t about whether rates are going to rise in the next month or the next quarter. It is still about generating a strong income when we expect base rates to stay low,” he added.

Mr Holt’s fund returned 28 per cent over the three years to October 9, compared to the IA Sterling Strategic Bond sector performance of 12 per cent, according to data from FE Analytics.