M&G’s Richard Woolnough has criticised August’s monetary policy easing by the Bank of England (BoE) and said he will cut back on his UK credit exposure if the central bank’s actions distort markets.
The manager of the £15.5bn Optimal Income fund is bearish on UK fixed income generally, having moved negative duration on the asset class last month, and said he would further reduce exposure should there be a long-lasting effect from the BoE’s move into the corporate bond market.
In a package of measures aimed at staving off what it saw as a likely Brexit-induced slowdown, the BoE said last month it will begin purchasing corporate bonds, having also further expanded its purchases of gilts and cut the base rate of interest to 0.25 per cent. But Mr Woolnough was sceptical of the need for such moves.
“The UK economy looks like it is in a strong and healthy recovery but the Bank of England has a different view,” he said.
“I don’t think there is much value in sterling bonds compared with other bonds; this makes us very different to our UK peer group but that’s where we think the value is.
“If the UK market becomes distorted then reducing our corporate bond exposure will be something potentially on the cards. [It] has got very dear historically compared with the US market. It’s not as cheap as it should be versus the euro bond market,” he added.
The manager’s Optimal Income fund has around 25 per cent allocated to sterling investment-grade and high-yield corporate credit.
Despite the shift to negative duration on UK debt, overall duration in the fund remains relatively stable at around 2.6 years. Mr Woolnough said he had bumped up US duration via long-term corporate debt.
“The US bond market will become the deeper, more liquid capital market. The UK will remain important but less so as capital markets move to those large, deep markets that exist in the euro and dollar.”
The manager said the US telecoms space, where he has been adding BBB-rated long-dated stocks, was the best source of value in current markets. He noted that 15-year AT&T debt was yielding close to 3 per cent compared with 1.5 per cent for BT and sub-1 per cent for Deutsche Telekom.
“You get paid really well for extending that duration,” he said. “That’s a feature of the US market where there has been lots of supply in that sector and less natural demand for long-end bonds.”
Implied default rates are also disconnected from reality, he suggested. The average default rate for BBB-rated debt is 0.4 per cent. But implied rates for euro, sterling and dollar-denominated credit range from 2.1 per cent to 2.9 per cent, according to the manager.
Mr Woolnough said he recognised the incongruity of extending duration in the US at a time when markets are pricing in a rate rise from the Federal Reserve this year.
“It’s not like US and euro interest rates are the same,” he said. “If 10-year bonds in Europe and the US were [both yielding] 1 per cent and you expected rates to go up [in the US] you would definitely own Europe.
“But you’re getting paid for that, people are pricing in a rate hike in the US. And look at the relative risk rewards in terms of upside versus downside.”
