Rathbones’ Bryn Jones is increasingly positive on ’too cheap’ credit, with markets pricing in defaults three times worse than in the depths on the Great Depression.
After a tough few months for corporate debt, he says investment grade is now discounting a 15 per cent cumulative default rate over the next five years, with 4.7 per cent the worst level on record amid the 1930s crash.
“More recently, the highest default rates ever were below 3 per cent in the 1990s, so markets are pricing in much worse corporate failure than the world has ever seen,” says Jones. “For us, this means credit is an attractive buy, as is our higher-beta ethical bond.”
Apart from the latter, Jones also runs the recently launched strategic bond fund for the group, designed to offer a diversified fixed income portfolio for clients.
He says many peers in the strategic bond sector are heavily skewed towards high yield and subordinated financial debt in the search for income, whereas his fund has tight limits on exposure to different parts of the market to keep risk under control.
Another key difference is that Jones will invest in high yield, emerging market debt and overseas credit via third-party funds to tap into expertise outside Rathbones.
“Most strategic funds invest directly in all areas and investors must therefore remain convinced the manager has strength across the market,” he says.
“Our experience is that a single house rarely has best-of -breed talent across such a wide universe.”
He also believes access to bond markets has become more difficult, with many individual issue sizes rising to above £100,000.
“Smaller clients do not necessarily have access to the strategic asset allocation skills required to manage their exposures, preventing proper bond diversification for all but the biggest private client portfolios,” he says.
Jones and team run the core areas of government and investment grade in the Rathbones fund, with external funds including Franklin Templeton global bond, Investec emerging markets local currency debt and JPM income opportunities.
Assets are split 50/50 between core and specialist, with a default allocation of 25 per cent in investment grade and 12.5 per cent each in linkers and gilts on the former.
In the external segment, the neutral position is 15 per cent each in emerging market debt and high yield and 10 per cent each in overseas investment grade credit and global government paper.
Restrictions include competing funds in the sterling strategic sector, as well as Jones’s ethical bond portfolio.
Head of multi-asset at Rathbones David Coombs – part of the investment team on the strategic bond – will also not own the portfolio in his funds to avoid any issues surrounding cross-holdings.
There is also no formal yield target in place, meaning the team is not forced into riskier parts of the market just to keep the income up.
At launch, the gross estimated initial yield on the fund is 3.84 per cent and, even in extreme circumstances, the group expects this to stay above that available on the FTSE Actuaries Government Securities UK Gilts under five-year index.
The ethical bond has a yield target of between 5-7 per cent and focuses on three core areas – emerging market growth, regulatory change in the banking sector and increased use of public transport as petrol costs continue to rise.
Looking across the bond market, Jones says gilts are offering an asymmetric return profile – with far more downside potential than up – and he is underweight duration as a result.
“If you have five-year gilts yielding 1.4 per cent and financial credit at 15 per cent, you could hold a portfolio of 100 financials – Axa, Aviva, Bupa and so on – and have 13 of these go bust before the government paper is better value,” he says.
“For us, that represents huge value in credit.”
He is also positive on index-linked debt, seeing inflation as more likely to prevail than deflation in the coming years.
Within the credit sector, Jones says insurance names are too cheap as is lower tier-two bank debt, especially bonds set to be called next year.
He is underweight utilities and short-dated sub-five- year debt in general, seeing little point buying assets yielding very little when there is so much income available elsewhere.