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Strat bond funds get a taste for triple trade-offs; The end draws near for Woodford

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A common bond

As we reported last week, another banner year for corporate credit hasn’t been accompanied by a dash for trash. Bond investors have had the luxury of seeing safer debt rally even more than its riskier counterparts.

Things aren’t quite so simple for those tasked with producing an income. Surging prices have pushed yields down further - creating a poser for the likes of strategic bond fund managers. 

To investigate how they’ve responded this year, we’ve looked at 30 such strategies currently held by DFMs, and updated our analysis of their BBB and CCC-rated credit exposures.

In the investment grade space, one trend stands out. Triple-B bonds, the lowest rung of IG debt, remain the dogs that haven’t barked - as it stands, worries over swathes of such debt being downgraded to high-yield level have proven misplaced. So it’s perhaps no surprise to see funds increasing their holdings here.

Nonetheless, as the chart below shows, the scale of this move is notable. Three in four strategic bond funds have upped BBB exposure this year. And many of these moves have been sizeable: of those who increased positions, the average weighting rose from 25 per cent in January to 30 per cent by the end of the summer. Much more of this and it could have implications for funds’ risk profiles.

There is a trade-off, however. Offsetting this move is a more prudent attitude towards the riskiest high-yield debt. Most have resisted the impulse to reach further for yield, with only a third upping their exposure to bonds rated CCC or lower. And average weightings here remain negligible, at 1.3 per cent of portfolios.

Fewer still have bought into unrated bonds, meaning the typical weighting here has actually fallen from 3.5 per cent to 3 per cent. There’s still some degree of caution on display from DFMs’ fixed income favourites.

Stable doors

This morning’s announcement that Woodford Equity Income is to be wound up marks another unwelcome return to mainstream headlines for Neil Woodford and the funds industry. But the decision feels like the right one. 

The idea that the fund would be able to safely reopen in December increasingly looked like a potential triumph of hope over experience. Even those investors prepared to wear a further 15 per cent loss this summer and await a turnaround, all else being equal, would undoubtedly have been influenced by the knowledge that others would be withdrawing en masse.

Extending the suspension would not have made the above consideration any more favourable when the gates were eventually opened. And arguing that investors should look to the long term is much tougher to do when they are trapped against their will. 

There were no easy options at this point, but a liquidation will at least provide some clarity to those investors. That’s a reasonable goal to prioritise, given the proportion of retail investors in the fund, and given they were originally promised daily dealing.

Could today’s decision could have been made sooner? An immediate wind-up would have been extreme. And some patience was needed come what may: ACD Link’s own analysis prior to the June suspension estimated a third of the portfolio would take six to 12 months to liquidate anyway. 

But Link evidently began to have serious doubts some time between August, when its suspension update said an end-of-year reopening was still viable, and September, when its subsequent update made no such comment. Others may have been sceptical prior to that point. Mr Woodford will now almost certainly lose the Patient Capital trust or see it face the same future, and recriminations will continue into 2020. The rest of the funds industry will be left to pick up the pieces.

Source of demand

The ray of light for wealth firms whose clients do still own a chunk of Woodford Equity Income is that all other assets have gone up in tandem this year. 

As a result, the hit to portfolios will be relatively easy to shrug off. And it may convince some of the more DIY-inclined of the importance of sticking with their adviser or wealth manager in future. 

Perhaps the episode will even prompt a few more advisers to turn to external DFMs. Because while the rush to outsource investment responsibilities has peaked, there’s still evidence that on-platform model portfolios, in particular, are sweeping up pots of cash. 

Standard Life announced last week that its DFM-focused Investment Hub now has more than £10bn in assets, five years on from launch. Nor do growth rates appear to be materially slowing down: the service added around £2.5bn in assets in 2017, and £4bn in the 21 months since then. Some of this money may have been transferred from MPS on other platforms. Nonetheless, it suggests the appetite for outsourcing is far from sated.

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