Prudential has hedged the corporate bond exposure within its £73bn with-pro-fits fund amid concerns about the impact of private equity on the markets.
It has hedged all of its high-yield bond exposure and 25 per cent of its investment-grade corporate bond holdings – which is equivalent to £4bn – as part of a wider move to “de-risk” the portfolio.
Investment director Martin Brookes says the outlook for corporate bonds is deteriorating after a benign six years for the asset class, with credit spreads set to widen over the medium term.
He says: “We feel that, given the amount of leverage brought to transactions and cov-lite loans, credit could be moving into more difficult times and we are now protected against this.”
“A lot of excesses have been seen in private equity and we need to unwind that. Over time, it is inevitable that the pace of the private equity market will slow.”
Derivatives markets are already pricing in a further widening of credit spreads but this has been slower to translate into the underlying bond markets.
Brookes says his main concerns are over the massive growth of the leveraged loan market, with several banks now struggling to offload this risk. Problems in the sub-prime market are also fuelling risk aversion.
He is more upbeat about the gilt market and has moved £1bn into the asset class to benefit from improved yields following the recent rate rises.
Much of this cash was switched over from Prudential’s Asian exposure as a result of profit-taking from Singaporean and Australian holdings.
The fund remains 55 per cent invested in equities, compared with 53 per cent at the start of this year and Brookes say he is comfortable with stockmarket valuations. He considers that Asia, Europe and UK continue to look attractive although he believes that the US is fully valued.
Commercial property continues to make up about 15 per cent of the fund after Pru reduced its UK commercial property exposure last year.