I have often reflected that it is easier being a credit fund manager than an equity one. I started managing equity money in the late 1980s before moving over to bonds in the early 1990s. So I have seen it from both sides. Why is it easier? Simply: the asymmetry of risk in credit investment removes the pressure to hold a credit security you don’t like.
If you get it wrong the penalty is not high – but missing out on Tesla, Amazon and Apple can be career limiting. This goes some way to explaining why passive management has a stronger hold in equities and why I believe that active credit managers can regularly beat indices.
Active bond managers are helped by the inefficiencies embedded in credit markets: benchmark fixations, rating requirements (increasingly embedded in regulatory rules for a subset of the market) and now Environmental, Social and Governance (ESG) considerations. From an active managers viewpoint this is all great news as it gives us the opportunity to add value by not getting caught in a herd mentality – but for clients adopting a passive approach or investing in quasi-active strategies (benchmark hugging), outcomes may be sub–optimal.
While ESG considerations are not new, investors focus on them and the scale of the inefficiencies around ESG investment are rapidly increasing. This growing inefficiency is really important as ESG funds’ total assets more than doubled in 2020 to $1.6tn – a tenfold increase since 2017 – and net inflows into ESG funds represented 15.5% of total inflows in 2020 (Source EPFR). So what is the inefficiency and how does it apply to credit markets? I think it comes in several parts. First: a box ticking approach that fails to properly account for ESG risk. Second: a preference for green labelled bonds over unlabelled but potentially more appropriate investments. Third: an overly narrow view on what ESG and Sustainability should focus on. This last point is well illustrated by the EU Sustainable Financial Disclosure Regulation (SFDR). It appears to me that the focus may be too prescriptive and could miss the bigger picture. At RLAM, our long-established sustainable funds focus on companies and issuers whose products and services offer a net benefit to society as well as ESG leadership. I think the social aspects of SDFR are under emphasised. Yes, climate change and the environment are vital but I am sure Covid will teach us more about the importance of social considerations.
Cash, government bonds and currencies
3 Month GBP LIBOR moved higher again – with the apparent push back on negative rates taking the level to 0.052% while the US rate stayed below 0.2%. Sterling was stronger on the week against both the USD and EUR – at 1.389 and 1.145 respectively – despite confirmation that the UK contracted by 9.9% in 2020 as a whole, leaving us a relative underperformer against European and global peers. My view is that a strong second half recovery looks likely given the UK’s so far successful vaccine rollout and the potential for higher consumer spending when the brakes come off.
10 year UK gilt yields ended above 0.5% for the first time since Feb 2020, with 50 year yields approaching 1%. Real yields were marginally higher with implied inflation again showing an upward tick. This was a pattern repeated in major markets – 10 year US and German rates rose by 5 bps with only Italy bucking the trend on confirmation of Draghi’s appointment as PM.
We are not running a lot of active risk in government strategies at the moment – and have a slight short duration bias. I think Germany bonds remain unattractive with best value in the US.
There was little change in sterling credit indices with gilt market weakness mitigated by further (marginal) spread contraction. There was an interesting new deal for ASDA – basically refinancing the recent purchase. Initial price talk on the secured and unsecured tranches proved to be way off the mark – with both issues being sold at much lower yields. At a coupon of 3.25% we had some demand for the secured but the pricing and leverage of the unsecured tranche meant we did not pursue our interest. It just highlights why we prefer Tesco secured debt. Our funds bought a new hybrid bond from Orsted and a senior debt issue from Deutsche bank. Overall, demand across the yield remained pretty strong and liquidity was reasonable.
Investment grade debt mirrored the movement in government markets but high yield continued to outperform with my preferred measure of credit spread dipping below 3.8%. Activity was pretty light and was mainly around adding to existing positions.
The highlight of my week was the launch of the Royal London Global Sustainable Fund – a fund that neatly fits into our sustainable range. With the launch of our new fund, RLAM manages nearly £4bn in sustainable and ethical credit and a globally focused fund will extend the strategies available to our clients. Rachid Semaoune (lead manager) will follow the same investment philosophy that applies to all our sustainable funds: a focus on companies and issuers whose products and services offer a net benefit to society as well as ESG leadership. I think our more holistic sustainable philosophy, which has served our clients well over several economic cycles, is better suited to our times than more narrowly focused approaches.
Past performance is not a reliable indicator of future results. 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. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.
Concentration risk: The price of Funds that invest in a reduced number of holdings, sectors, or geographical areas may be more heavily affected by events that influence the stockmarket and therefore more volatile.
Credit Risk: Should the issuer of a fixed income security become unable to make income or capital payments, or their rating is downgraded, the value of that investment will fall. Fixed income securities that have a lower credit rating can pay a higher level of income and have an increased risk of default.
Efficient Portfolio Management (EPM) Techniques: The Fund may engage in EPM techniques including holdings of derivative instruments. Whilst intended to reduce risk, the use of these instruments may expose the Fund to increased price volatility.
Exchange Rate Risk: Changes in currency exchange rates may affect the value of your investment.
Interest Rate Risk: Fixed interest securities are particularly affected by trends in interest rates and inflation. If interest rates go up, the value of capital may fall, and vice versa. Inflation will also decrease the real value of capital.
Liquidity Risk: In difficult market conditions the value of certain fund investments may be difficult to value and harder to sell, or sell at a fair price, resulting in unpredictable falls in the value of your holding.
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Interest rate risk: Fixed interest securities are particularly affected by trends in interest rates and inflation. If interest rates go up, the value of capital may fall, and vice versa. Inflation will also decrease the real value of capital.
The Royal London Global Sustainable Credit Fund is a sub-fund of Royal London Asset Management Bond Funds plc, an open-ended investment company with variable capital (ICVC), with segregated liability between sub-funds. Incorporated with limited liability under the laws of Ireland and authorised by the Central Bank of Ireland as a UCITS Fund. It is a recognised scheme under section 264 of the Financial Services and Markets Act 2000. The Investment Manager is Royal London Asset Management Limited. For more information on the trust or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.co.uk. Most of the protections provided by the UK regulatory system, and the compensation under the Financial Services Compensation Scheme, will not be available.