TwentyFour Asset Management has been buying debt not eligible for the Bank of England’s (BoE) bond-buying programme in the belief that investors are underestimating the extent to which these securities could benefit from the central bank’s latest phase of quantitative easing.
The BoE programme, which commenced on September 27, sees it purchase sterling corporate bonds that satisfy criteria such as having an investment-grade rating from at least one major ratings agency and being issued by a non-financial entity.
It follows a similar initiative by the European Central Bank (ECB) that was launched in June.
Gordon Shannon, who runs the £323m TwentyFour Corporate Bond fund with Chris Bowie, said that while the BoE’s decision to buy £10bn in corporate bonds over an 18-month period had benefited debt eligible for purchase, market dynamics could now benefit other bonds, too.
“We got involved in the bonds that are outside the BoE’s and the ECB’s programme,” he said.
“The eligible bonds have quite tight yields. As other investors seek out a replacement for the yield that’s been squeezed out of the eligible names, they will allocate assets to sectors outside the programme. We will get that portfolio effect.”
This has seen the managers add to financial debt, which is ineligible for the programme, such as bonds from insurers Lloyd’s of London and Phoenix.
The duo have also topped up on secured debt – bonds that are backed by assets as collateral – from the likes of Telereal, secured on BT telephone exchange buildings, and the RAC. In addition, they have bought corporate hybrids from Orange and Scottish and Southern Energy.
On the latter Mr Shannon noted: “We like the hybrid sector, with junior debt from non-financial corporations. If there’s a company you feel comfortable with, like Scottish and Southern Energy, you can buy more junior pieces of their debt and get more return. It has a yield of 4.5 to 5 per cent.”
The team is now looking at the possibility of upping its weighting to high yield, which remains well within the 20 per cent limit for the fund.
“We still have room to add in high yield,” Mr Shannon said. “We are well below our limits when good opportunities come up. We will probably add a bit to the hybrid sector and maybe the secured bond sector, such as debt from Heathrow.”
And while high-yield allocations could also take in financial bonds, possibly from the likes of Lloyds or Barclays, the team has in some cases been moving away from the sector because of contagion fears.
“We reduced exposure to Tier 1 bonds as the Deutsche Bank story evolved,” Mr Shannon explained.
“We didn’t have any credit concerns with the likes of [portfolio holding] Nationwide, but the way that sector works, there would be contagion if we have a worse outcome with Deutsche Bank. The sentiment would fall. There would be volatility.”
This concern forms part of broader angst among the managers around political instability, particularly in Europe.
“What’s keeping us most busy is keeping up with the various political news, not just the US election,” Mr Shannon said.
“It’s arguably the most important [issue] in the world, but almost all the outcomes are reasonably benign. It won’t make much difference for the bonds in our portfolio.
“In Europe we have got events, including trouble forming a government in Spain [now resolved], the Italian referendum and the German elections. The financial space is one of the areas hardest hit by politicians.”
The TwentyFour Corporate Bond fund has returned 8.9 per cent over one year, compared with an average of 9.5 per cent by its IA Sterling Corporate Bond peer group, data from FE Analytics shows.
Ratings breakdown of Corporate Bond fund
What does BoE mean by eligible bonds?
While the Bank of England has a range of debt to choose from, its bond-buying programme comes with multiple caveats.
To be eligible, bonds must be rated as investment grade, have a minimum amount in issue of £100m and a minimum residual maturity of 12 months.
The central bank said it would also consider the issuer itself, noting: “The bank will purchase bonds issued by companies that make a material contribution to economic activity in the UK.
“Companies with significant employment, or with their headquarters, in the UK will normally be regarded as meeting this requirement. The bank will also consider whether the firm generates significant revenues in the UK, serves a large number of customers, or has a number of operating sites in the UK.”
One notable exemption from the programme is corporate bonds issued by banks, building societies, insurance companies, or other financial sector entities regulated by the BoE or the FCA.
Bonds with complex or non-standard structures are also ineligible, along with convertible bonds and corporate bonds with “callable features”.
