Trading on negative valuations

Old Mutual’s Christine Johnson talks to Gary Jackson about adding more risk and why everything could be better than most fear.

Christine Johnson 480 large

Q: You have been introducing risk into the portfolio. How was this executed?

A: Over the summer there were very major improvements in the situation in Europe in particular. As well as that, the economic situation in the US is much better. We added some more high-yield to the portfolio and then after the ECB’s [outright monetary transactions] announcement we added some peripheral credits. Finally, which is consistent with adding risk, we reduced duration slightly.

Q: What purchases have you made?

A: We have been deliberately seeking to add names which are more sensitive to growth. They performed astonishingly badly in the first seven months of the year because everyone knew there was this growth slowdown on the way. So we started looking at mining companies, steel companies, US autos. It is not necessarily that we are very optimistic about the future for world growth – it is more that we think the discount which has been put in place for those names is too large compared with the fundamentals of the businesses and the likely future path of growth.

Q: Did you sell anything to get these into the portfolio?

A: It was quite a natural rotation. We have been letting go of the very defensive ones, which have done well. A lot of utility paper we have let go, we reduced our exposure to the gilt market which previously we had an outright holding in. So it was ultra defensives into slightly more economically sensitive credits.

Q: You said the economically sensitive names had an “astonishingly” weak run. Has buying them started to pay off?

A: Corporates are actually in very, very good shape in terms of balance sheet strength. They are very capable of withstanding an economic slowdown. If you got through 2008, the idea that growth ticks down another couple of basis points is not really that big a problem. But they have performed very badly, so the discount looks too large. As well as that, the difference between similar companies in Europe and in the US is too large. The fear factor that infected everything that was European was way too disproportionate on some names. That gave us an opportunity to get in.

Q: Banks have been back in the headlines in recent months. What’s your view on banks?

A: We have been underweight for a while now but have actually started to add paper back. Where we have chosen to add is either in the US or in a couple of the strongest of the peripheral names. In the US, it is about banks being in very good fundamental shape and awash with liquidity – they have an embarrassment of cash. With buying the strongest of the peripheral names, we are very optimistic at the nature of the intervention shown by the ECB – in terms of really drawing a line under the worst case scenarios for the periphery. What has been completely pushed off the agenda for the foreseeable future is some sort of disorderly break-up. With that off the calendar, it gave us the confidence to buy BBVA, Santander and Entessa.

Q: So what is the biggest risk on your radar right now?

A: What has been our number one risk for the last few months – and you may be surprised hear this, but it is everyone’s risk – is ‘what if everything is OK?’ Everyone is defensively positioned, everyone is anticipating that the global slowdown will continue unabated and everyone is so used to being frightened all the time and jumping at shadows. Your risk case from here is ‘what if none of the bad things happen?’ You then have a world where everyone is going to try and squeeze into the more risk-sensitive assets, potentially in a kind of scramble.

This links directly to our idea of buying some economically-sensitive names and buying more bank paper. We think what the ECB has done has removed a major tail risk from the market. The thing that nobody is ready for is what happens if the US economy starts to grow quite strongly next year. There are signs that the US housing market could tick up and that means construction and employment could start to tick up strongly next year. And let’s imagine that China does some stimulus because they are not going to stand there idly and watch their economy shrink. We want a stake in that future where everything hangs together.

Q: There has been a lot of talk about corporate bond liquidity. Is this something you are concerned about?

A: We are not concerned in the sense of how we go about running the fund, but we are very mindful of it. What we have done is adapt the way we invest. Rather than being completely beholden to the cash bond markets and thinking we can execute all our strategies through that mechanism, we have spent a lot of time in the last few years making sure we are able to use CDS in the way of indices, that we use futures and that we introduce swaps. This gives us more tools and allows us the flexibility to respond to the situation without being completely beholden to the cash bond market. With the best will in the world, we do not think the liquidity in the cash bond market is going to improve very much in the next few years.

Q: Do you have an outlook to the end of the year?

A: We are a little more optimistic in terms of returns to the end of the year but we are mindful that certain asset classes have done extremely well and it is prudent to start taking a few profits where you can. But other than anything it is this anticipation that we might have a re-enforcement of some good news and, if nothing else, a lack of bad news which will give risk assets something of a boost to the end of the year.


Christine Johnson is the manager of the £465.1m Old Mutual Corporate Bond fund