Royal London Corporate Bond manager Sajiv Vaid is looking for solid income with downside protection in the unrated bond market
The £657.4m fund invests almost exclusively in investment grade bonds, however it does hold some bonds that have been re-rated as junk, but Vaid remains convinced about the investment. They make up about 5 per cent of the portfolio.
Unrated bonds account for 10 per cent of assets, however virtually all are investment grade when measured on Royal London’s in-house systems, he says.
That is double the Sterling Corporate Bond sector average, but he says that helps boost the fund’s distribution yield to 5 per cent.
John Lewis is one example of an unrated bond, however the retailer’s issue is relatively unusual for the fund, he explains.
Most of the unrated bonds benefit from charges over property or other assets that can be recouped if the company defaults, he says.
Grosvenor Finance – a 0.7 per cent position for the fund – is a floating rate note of 1.4 per cent above gilts with security over the Duke of Westminster’s property in Belgravia and Westminster.
“A BBB-rated bond from a company like Hammerson will yield about 1.5 per cent over government bonds, but with no security, so if they default the banks will get most of the assets.”
The ability to look outside of rated bonds and find good income for less risk is something the fund has always done and will continue to do, he explains.
“Investors tend to bias their investments to whether a bond has a rating and is in the benchmark before they can take a view on it.
“That’s an eminently reasonable strategy, but we’ve been managing money for a long time and know these are the opportunities for good income and good security.”
The team’s key philosophy is “exploiting inefficiencies” in the market and those assets help boost returns because of the complexity, albeit sometimes at the expense of liquidity, he says.
However, it has not all been plain sailing. Despite the fund outperforming the sector over the past one, three and seven years to 11 December, it performed noticeably worse than peers in the aftermath of the financial crisis.
About 40 per cent of the fund has some form of asset-backing, whether for issuers like Grosvenor Finance or in covered bonds and social housing, he says.
Asset-backed exposure was the main cause of the fund’s underperformance in 2008-09, he admits.
But he thinks that was a unique event and unlikely to punish the asset class so much again.
Since the crisis the asset-backed, structured debt market’s liquidity fluctuates, sometimes more liquid than benchmark holdings and other times less so, he explains.
“But we’re not in the business of producing liquidity, but to provide a high level of income.
“The crisis was – and it’s a well-worn phrase – a once in a lifetime moment and the indiscriminate nature of the event meant the sell off was violent, no matter what you were holding.”
Long-term investors ”suffered”, particularly those exposed to asset-backed securities, such as covered bonds that had security on pools of loans that everyone was nervous of and structured debt like CDOs.
“It didn’t matter how good those assets were, no-one wanted to put a price on them,” he says.
“As we came out of the crisis it’s fair to say that the recovery wasn’t as strong as some people may of expected and that’s because the asset-backed and structured debt took a very long time to revive.”
A low position in supranationals also dragged performance down, he says.
The fund has the ability to have up to a fifth of the portfolio in high yield and sovereign debt, but he tries not to exercise it as investors want investment grade exposure.
Flows into investment grade funds have been strong all year, as the asset class “ bundles along” in the low growth world, he says.