The focus is very much back on fixed income credit ratings and BBB-rated bonds in particular.
The size of the market, increasing leverage and the potential for downgrades has prompted the Bank of England to warn of the possibility of “dysfunction, disorderly price moves and losses for investors”.
This week’s best in class fund has a manager who views credit ratings differently.
He believes they are simply an expression of credit-worthiness of the issuer and that investors are over-reliant on credit rating agencies and their ratings.
He believes this makes it possible to exploit market inefficiencies and mis-priced credit risk.
He is also of the belief that an unrated bond is not necessarily more risky – it may simply be that the company has chosen not to pay the agency to assess the bond.
He is well-known for swimming against the tide and investing in high-yield bonds that lack a credit rating.So, with careful due dilligence, this creates a wider investment universe to uncover fixed income opportunities.
The Royal London Corporate Bond fund has the flexibility to explore these areas.
Fund manager Jonathan Platt has been applying his long-term, macroeconomic approach since joining Royal London in 1985. In 1992 he became head of fixed interest.
He is well-known for swimming against the tide and investing in high-yield bonds that lack a credit rating.
Shalin Shah became co-manager on the fund in 2017.
The fund has just celebrated its 20th anniversary, with Mr Platt at the helm since launch in March 1999. His philosophy has borne fruit in both the medium and long-term.
Since launch to June 19 2019, the fund has returned 169 per cent, according to total returns in sterling data from FE Analytics, while in the last five years it has risen 31.2 per cent, compared to an average return of 132.6 per cent and 24.9 per cent respectively for the IA Sterling Corporate Bond sector.
It also has a distribution yield of 3.76 per cent, according to the fund factsheet.
Mr Platt's approach emphasises longer-term investment horizons, ensuring that investors are adequately paid for overall credit risk – without an assumed safety net of constant liquidity.
The tested philosophy and processes, combined with an efficient research team structure, provide a solid foundation to exploit short-term valuation anomalies.
As mentioned, Royal London’s competitive advantage lies in its belief that sterling credit markets offer investors long-established inefficiencies given the focus of other managers on benchmark orientation, the use of credit ratings as a key driver of security selection, and the inefficiency created by large-scale managers having to focus on the most liquid issues.
The core of its approach is to concentrate upon the most reliable sources of outperformance.
First up, this includes security selection. Mr Platt's philosophy is to look where others are not, to create diversified and robust credit portfolios.
This means an emphasis on bond covenant analysis and attention to the security offered by a particular bond.
Duration is also a key determinant of performance and is managed to reflect views on long-term interest rates.
Asset allocation is also a source of outperformance and the team are prepared to be different from the consensus.
Finally, positioning in terms of the yield curve will be used to enhance return.
The process is risk aware, concentrating on avoiding losers rather than picking big winners, and the fund has a lower risk profile than many of its peers.
The fund currently has 342 holdings, almost 20 per cent of which are held in bonds rated BB or below or unrated, to support the team's beliefs.
The largest sector exposures are currently structured (30.4 per cent) and banks and financial services (14.1 per cent), the fund factsheet to April 30 2019 shows.
This fund is a strong core fixed income holding which offers something different from many of its peers.
It has stood the test of time to provide strong risk-adjusted returns, offering access to an efficient research team structure, which has proven its success.
Darius McDermott is managing director at FundCalibre
