In 2013 we see corporate bonds performing the essential job of providing stable income to investors. The fund does this while focusing on outperformance opportunities brought on by inherently volatile markets. Economic uncertainty will ensure fixed income continues to remain of interest to investors.
While valuations have become less compelling than 12 months ago, we see interesting opportunities in specific sub-sectors including high quality corporate hybrids, with comparable yields to sub-investment grade debt, and believe superior stock selection will be more important in driving returns.
Our corporate bond fund benefits from a global platform of credit analysts allowing fund managers to access the best opportunities across global markets.
Inflows into corporate bonds have taken place over many years, and we believe that the market overestimates how quickly that money will flow back into other asset classes, such as equities.
For this to occur we need to see a sustained improvement in the economies of the UK, eurozone and more globally. Equities remain volatile, cash is a negative investment after inflation and investments in government securities are not as risk free as they once were. Against this backdrop corporate bonds continue to make sense.
The fund positioning:
Credit: We have taken a more defensive credit risk position, since the beginning of the year, maintaining our core exposure and looking for better opportunities to buy preferred names.
Sector. We have reduced exposure to financials generally and corporates in the periphery. We favour corporates with strong cash flows and stable ratings outlook.
Macro Views: We believe gilt yields can remain low and volatile for some time. We continue to approach interest rate management tactically.
Overseas views: We own selective US dollar and Euro credit, hedged back to Sterling, adding diversification and liquidity.
Ben Edwards is co-manager of the UK Corporate Bond fund at BlackRock
Over the recent months, the credit markets have seen the re-emergence of corporate hybrids as a financing tool for companies. This year, the hybrid market has grown to approximately €33bn in the sterling and euro credit markets, as a number of corporates look for new ways to diversify their funding, stem negative rating trajectories and tackle mounting capital expenditure pressures.
The instruments themselves have been structured with optional coupon deferral, so the issuer can stop paying coupons if they decided to suspend dividends. However these interest payments are typically settled cumulatively at a later stage. They have a fairly complex call structure with step-up language that entitles the issuer to 50 per cent equity credit, which although requires large issue sizes to generate the required funding, is the major attraction to corporate treasurers.
On the other side of the fence, the attraction of these instruments to yield-starved credit fund manager is obvious. If investors are comfortable with the issuer’s commitment to pay the coupon and their ongoing willingness to strengthen their balance sheet, the yield pick-up is very attractive. For example, the recent KPN GBP Hybrid currently has a yield to call of approximately 6.6 per cent.
Looking to the future, we expect the hybrid market to grow steadily and demand to be strong but we remain cautious. We have yet to see how these high-beta instruments perform in a material sell-off and despite the yields being clearly attractive, in instances where the issuer has limited options left to protect their financial profile, the compensation for this deeply subordinated instrument is questionable.
James Vokins is credit fund manager at Aviva Investors