With stickier and higher inflation here in the UK and across the pond, the end of easy financial conditions seems to be upon us.
The Bank of England has already moved to raise interest rates and a March rise in the US seems a done deal. So, the immediate outlook for many global bond markets looks to be increasingly treacherous, especially for holders of duration-sensitive assets.
So why would you own credit today? Possibly to position yourself for future returns, according to Ben Edwards, manager of this week’s best in class, the BlackRock Corporate Bond fund.
A lot of the groundwork in finding the best opportunities for this fund is aided by the centralised dealing desk at BlackRock, including its analytic quant desk and trading team, its bank of analysts on six specialist sectors, plus collaboration with the other funds on the sterling and European fixed income desks. Edwards selects the best ideas from these sources and the result is a high conviction portfolio that typically holds around 150 companies.
He will take meaningful active credit views and look to exploit the inefficiencies in the market and can purchase both corporate and government bonds. The corporate bond element may include non-UK businesses and some Euro-denominated debt where tactical opportunities arise, though both are limited in their exposure in the portfolio. The non-UK company holdings will typically have sterling-denomination, meaning the currency exposure will be 90 per cent plus sterling.
Edwards aims for a neutral portfolio duration of 6.5 years, with a range of 5.5 to 7.5 years allowed. As such, the fund will usually exhibit less interest rate sensitivity and greater diversification than a number of riskier peers in the sector. Duration today is about 5.75 vs 8.53 for the index.
Edwards says he has been of the view for some time that inflation would not be as transitory as people thought, but until recently, risk markets have proved to be remarkably resilient to the narrative. Why? “Because although we are now in a tightening environment, there is still a lot of cash in the economy, so the signals have been absorbed more slowly,” he says.
Having had a decade or more when the central banks have done what they want, inflation is now forcing them to act. Since the summer of 2021, yields have almost doubled, and Edwards is now seeing things he wants to buy. “Credit is better on valuations and, unless we move swiftly into a recession, is definitely worth looking at,” he notes.
The market now seems to agree that the US Federal Reserve is behind the curve, so rate rises are finally being priced in. Edwards says he does not think the BoE can do more than five hikes this year as the economy simply could not take any more. But the risk is still there and, if inflation continues to surprise for the next few months, the drift lower could be slower and the narrative could change.