Our views

Beware the bond egoist!


Martin Foden, Head of Credit Research

31 January 2018

One liquidation, one leveraged buy-out and a smattering of shattering profit warnings and we’re not even a month into the new year. Whilst we may lament an unseasonably active start to 2018, these events do provide a striking reminder of the skewed nature of corporate bond returns. At issue, the income offered by bonds issued by Carillion, GKN and Dignity would have been relatively low, yet buyers of these bonds could now be facing material market losses.
Combine the asymmetric risk profile of individual corporate bonds with a bond fund manager who runs concentrated portfolios and chases yield, and the consequences of these events on fund performance can be equally skewed.
How do we avoid this? We build portfolios that reflect our clear understanding of both bond risk and the fundamental limitations of investor foresight. In practice this means two things – security and diversification. We harness the tangible protection of lending to our issuers in the most secure way possible without compromising portfolio yield and, crucially, run heavily diversified bond portfolios to dampen the risk of any one, often unforeseeable, corporate event undermining overall returns.
The typical genesis for corporate failure is management complacency and arrogance evolving into hubris and recklessness. Whilst we can never fully guarantee that this will not afflict some of the companies we lend our clients’ money to, we can ensure we do not compound the consequences by allowing the same weaknesses to taint our bond portfolios. We have been managing diversified bond portfolios with a strong bias to secured bonds for many years, through many different corporate cycles. The events of the past few weeks give us little reason to change this long established approach.

One liquidation, one leveraged buy-out and a smattering of shattering profit warnings and we’re not even a month into the new year. Whilst we may lament an unseasonably active start to 2018, these events do provide a striking reminder of the skewed nature of corporate bond returns. At issue, the income offered by bonds issued by Carillion, GKN and Dignity would have been relatively low, yet buyers of these bonds could now be facing material market losses.

Combine the asymmetric risk profile of individual corporate bonds with a bond fund manager who runs concentrated portfolios and chases yield, and the consequences of these events on fund performance can be equally skewed.

How do we avoid this? We build portfolios that reflect our clear understanding of both bond risk and the fundamental limitations of investor foresight. In practice this means two things – security and diversification. We harness the tangible protection of lending to our issuers in the most secure way possible without compromising portfolio yield and, crucially, run heavily diversified bond portfolios to dampen the risk of any one, often unforeseeable, corporate event undermining overall returns.

The typical genesis for corporate failure is management complacency and arrogance evolving into hubris and recklessness. Whilst we can never fully guarantee that this will not afflict some of the companies we lend our clients’ money to, we can ensure we do not compound the consequences by allowing the same weaknesses to taint our bond portfolios. We have been managing diversified bond portfolios with a strong bias to secured bonds for many years, through many different corporate cycles. The events of the past few weeks give us little reason to change this long established approach.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.