Fixed income managers have been reassessing portfolios as a predicted imminent end to the Bank of England’s (BoE) corporate bond buying scheme kickstarts market volatility.
While corporate bond markets have appeared stable in recent months with overall credit spreads broadly unchanged, managers expect this could change if the bank exits as a buyer, something tipped as a likelihood in a matter of weeks.
In September the BoE commenced its programme of buying “eligible” corporate bonds, including certain non-financial names. It initially targeted £10bn of purchases over 18 months, but has already picked up more than £9bn. The bank suggested calling time on its programme early, with commentators predicting an ensuing bout of volatility.
Chris Clemmo, fixed income dealer at M&G, said: “Markets have been using [central bank buying] as a tool to manage risk. Some bonds are trading very near record tights, so should there be any selling pressure, particularly in the context of Article 50, sterling bonds could widen quite materially.”
Specific names already look to have been affected by expectations that the BoE could exit.
Vodafone, one of the major issuers of debt since the BoE opted to begin its programme, has seen its yield spread over government bonds increase from around 165 basis points (bps) when debt was issued to some 215bps now.
Another issuer that took advantage of the buying programme, British American Tobacco (Bat), had also seen spreads widen but to a lesser extent, said Royal London Asset Management (RLAM) head of fixed income Jonathan Platt.
The longevity of this trend remains difficult to forecast, he added.
“A problem is anticipating how much things are already priced in and how much they continue,” Mr Platt said. “I would expect further widening in the short term.”
Given the context, managers have been assessing which companies could fare well in an environment of enhanced volatility. Mr Platt noted that while he would be an opportunistic buyer of favoured names, issuers such as Bat and Vodafone should be avoided because of their sensitivity to market movements.
Bond manager plays could be highly sector specific due to the way the BoE has gone about its bond purchase scheme – excluding financials while looking for companies that make a “material contribution” to the UK.
Some areas where the central bank has been an active buyer include energy companies, transport names, utilities and housing associations.
In anticipation of an end to the programme, Lionel Pernias, UK head of buy and maintain credit at Axa Investment Managers, has favoured a move away from selected “eligible” names.
He said: “We are reducing housing association exposure and buying universities, where the spread movement is very limited and we have some rating uplift on top of that.”
Others shared similar views, though these are based more on a renewed focus on fundamentals in the absence of central bank activity.
Luke Hickmore, an investment manager at Aberdeen Asset Management, said the BoE’s exit meant an end to distortion in the market, allowing a return to a focus on the fundamentals of a stock.
He said: “We are trying to buy companies where management activity is limited, in areas which are heavily regulated like financials and utilities.”
