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Asset allocation: Henderson’s de Bunsen nervous on corporate bonds

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Does the corporate bond market know something everyone else doesn’t? This is the question currently occupying Henderson multi-asset team fund manager James de Bunsen.

Credit spreads are widening materially, more than the underlying data would appear to merit, and for de Bunsen it warrants some caution.

He says the problem might be explicable were it simply high-yield spreads that had widened out because high yield is “over-owned” and had become very expensive. The concern is investment grade spreads have also moved significantly and the market believes a rise in default rates is possible, even for the highest quality companies.

De Bunsen says: “We are looking at this phenomenon and asking whether we are missing something. Bond investors tend to think of themselves as less blindly optimistic than equity investors. The shift has been meaningful at a time when defaults are not picking up. The stress in the energy and resources sectors has now spread elsewhere.”

He believes this suggests a change in mentality. The bond markets have delivered strong returns for investors over the past five years and no one is expecting losses. He adds: “This may be a more difficult world. The risk aversion in credit markets may take hold in equity markets.”

The group has responded by taking money out of its dedicated high yield exposure, reducing the weighting from 4 per cent to 2 per cent in the Multi-Manager Income & Growth fund. De Bunsen says the team retains some strategic bond fund exposure.

The team has also reduced its equity weightings in the fund by around 5 per cent, which is currently sitting in cash. Specifically, de Bunsen has reduced the European and Japanese holdings in the fund. “This downturn started with China and emerging markets and a lot of money has came out of those markets. In contrast, there was a lot of money still going into Japan and Europe.” This suggested prices had been pushed too high.

He remains relatively positive on emerging markets although admits the outlook varies hugely for different emerging markets. India, for example, has the “perfect storm” of falling interest rates, rising growth and a reform agenda. This is in contrast to Brazil, which “looks dreadful”. That said, the Indian market has barely fallen, while the MSCI Brazil is down 47 per cent over the past year in US dollar terms to 8 October.

De Bunsen says: “The danger is there is an accident, possibly in Brazil, but that is not our central case. The valuations provide a significant margin of safety. Who is left to sell? We could see emerging markets outperform from here. We hold a very marginal overweight in our funds.”

He feels the same way about the UK market, which has been hit hard because of its mining and commodities exposure. With some stocks down 60-70 per cent, he believes it would not be difficult for them to rally 20 per cent. There is no explicit exposure in the fund, but they are more positive on the UK as a result.

Part of the reason for de Bunsen’s caution is the variability of the economic data. “What’s the catalyst for everyone to feel happy and put money into equities once again? The support has gone for equity and high yield. Every time there was this type of volatility, the central banks have done quantitative easing, but now they’ve done their ‘big bazookas’.”

He points out there was a time when bad data was good for risk assets because it meant central bankers were likely to do more QE. He says: “Manufacturing and jobs data have weakened a little, just at the point where we thought we’d reached take-off velocity. That said, the consumer side is strong and the housing market is doing well.”

In the US, the group believes the data will improve. A pattern has emerged of weak data in the first quarter with a bounceback in the latter part of the year. Nevertheless, the US equity market looks very expensive and leaves little room for error should economic data disappoint.

De Bunsen says it has been a good time to be invested with the “winners”, strong companies with stable earnings growth, but he believes it is prudent to keep recycling profits into those areas of the market where sentiment has become very bearish and where valuations offer a greater margin of safety. If the credit market is right and recovery is weakening, then these areas may have less far to fall.

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