The Analyst: Corporate bonds aren't always boring
Saturday 10 May 2008
In a number of articles this year, I have highlighted the attractions of corporate bonds. I am pleased to report that in the last few weeks these have been moving up quite strongly. For example, the Invesco Perpetual Monthly Income Plus Fund has risen almost 4 per cent (with income reinvested) since I featured it in February. I remain positive on the prospects for these funds over the next few years.
This week I will examine a new bond fund from Legg Mason, their Global Multi-Strategy Fund. Although the fund will carry the Legg Mason brand, the actual management will be done by its Western Asset subsidiary. They are the third- largest fixed income investment house in the world, with more than $600bn (£300bn) of assets under management. They are true bond specialists.
The lead managers will be Ian Edmonds, whose background is in European high yield bonds, and Mike Zelouf whose specialises in emerging market bonds. These individuals are based in London and have the support of 30 other professionals in London and 172 globally. This is very much a team-based approach and it's worth noting that Western Asset has not lost a senior manager in the last 15 years.
The fund has an emphasis on flexibility and on holding only the team's best ideas. Its goal is to provide the best total returns irrespective of yield, so those investing for income should note that the yield may at times be relatively low if the manager believes that capital appreciation is a surer path to profit.
While this approach will not suit everyone's needs, I believe it is generally a better philosophy than trying to seek out the highest possible yield all the time. Constantly chasing a high income can lead to significant capital falls, which over time will erode your income, too.
The investment process starts with a 13-strong strategy group that meets twice a week to determine how all of Western Asset's funds should be positioned in terms of different types of bonds, their maturity and geographic and sector allocations. As a result of this, the weightings between different assets will change over time as market conditions ebb and flow.
This active approach allows the managers to seek opportunities in whichever areas they expect to deliver the best potential returns. Western Asset has been running a similar fund offshore since 1996 and it has established a strong track record.
It is expected that the fund will be aggressively positioned at launch; the managers see plenty of opportunities following the amount of forced-selling that has been going on in the market. They are expecting a strong recovery as the bond market overcomes these technical issues. Such bullishness means that the fund will have something in the region of 32 per cent exposure to high yield, 18 per cent in investment grade, about 8 per cent in emerging market corporate bonds and 8 per cent in emerging market government bonds.
In addition to this, there will initially be some small exposure to Asian currencies, while some 20 per cent will be invested in US agency mortgage-backed securities such as Freddy Mac and Fannie Mae where spreads have gone from around 0.4 per cent to around 2.6 per cent. Currency risk will be largely hedged back into Sterling, with at most 20 per cent of the portfolio exposed to currency movements. In addition, the fund will have a large number of holdings in order to diversify away some of the risk.
For example, the portfolio of the existing offshore fund contains approximately 600 holdings. It pays a monthly income and will have a yield in the region of 6-8 per cent, but as I said earlier this could vary quite a bit over the years.
The managers believe that bond defaults will rise as the global economy slows, but that the level of defaults will be nothing like what current bond prices currently suggest. Basically, Western Asset are telling me what most bond managers have been saying for the last two or three months; that there is tremendous value in bond markets.
This new fund offers the opportunity to take advantage of this phenomenon on a global scale and with a group whose only raison d'être is investing in bonds. So if you are one of those who think that bonds are boring maybe you should take a closer look at this fund, which should be able to select from the best opportunities from across the world.
Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent
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