Richard Woolnough has found sources for bond market optimism in the wake of the US presidential election, noting riskier US debt performed well even as Donald Trump’s triumph sparked a developed market sell-off.
Since the US election on 8 November, 10-year US Treasury yields have risen 0.46 percentage points, with 30-year rising 0.39 percentage points, as markets bet on the return of inflation. By contrast, yields on US high-yield debt have moved slightly lower, reducing the spread between riskier US credit and government bonds.
The manager of the £16.1bn M&G Optimal Income fund said he thought Mr Trump’s tax and trade policies could be bullish for credit.
Mr Woolnough said Mr Trump’s commitment to reducing the corporate tax rate would see debt issuance became less attractive in future, and predicted this reduction of supply would be advantageous for bondholders.
“There will be attempts to make the corporate tax rate lower, which is good for corporates. But a strange consequence is that when you borrow money you can offset interest against your earnings [tax relief]. So if taxation is lower, it makes that less effective and the asset capital model will favour more equity on the balance sheet and less debt.
“There could, potentially, be less debt issued, which is good,” he added.
The fund manager – whose fund has seen returns improve in 2016 after sustained outflows and a period of underperformance – added that Mr Trump’s plan to encourage firms to repatriate offshore assets would also be a boon for bondholders, as companies would have more cash on hand with which to buy back their own debt.
“We’re just thinking a little bit more about this tax and repatriation – it helps US credit a little bit more and encourages us to own a bit more.
“If it does get to levels that are attractive and the market does get very scarce, then we will start putting duration back into our portfolio,” he added. The Optimal Income fund’s modified duration is currently 1.9 years, at the lower end of its historic range.
According to the manager, the recent sell-off in the government bond market was a notable adjustment given how low interest rates had been.
“There should be a term premium and the yield curve should be steeper. I think the term premium will reappear either through the unwinding of quantitative easing, or activity at the Federal Reserve. My main concern about a bear market is the [longer] end of the curve,” he added.
Mr Woolnough said he continued to believe the UK corporate bond market could shrink as a result of Brexit and other factors. He believed more companies would start to focus on issuing debt in the US and Europe instead – and even foresaw similar moves in equity markets.
