I am joined today by Mohamed Siddeeq, senior portfolio manager at HSBC Global Asset Management and a 30-year plus industry veteran, who also specialises as a Sterling Corporate bond manager.
Q. Why should an investor consider buying Sterling Corporates now?
Now is a good time to buy corporate bonds – simply put, better returns for less risk. Bonds can provide a better risk adjusted return than those of equities. In fact, Sterling Corporates have outperformed the FTSE 100 year-to-date in 2020 on a total return basis, and also over the last 5, 10 and 20-year periods.
Going forward, whilst total returns may be lower than in the past, we could see this relative outperformance pattern repeated, as given the pressure that companies are under, equity dividends are uncertain and can be cut during times of financial weakness. Bond interest is a more consistent income stream as it is contractually paid and senior to dividend income. So in volatile markets, bonds can be more attractive on a relative return basis – locking in returns and helping investors to preserve capital.
The available Sterling Corporate bond market universe is significant with around £690bn and this is one of the largest bond holdings by UK investors, demonstrating that bonds remain a popular allocation. And whilst popular, Sterling Corporate Bonds is not an asset class that is at the top of the market. Undoubtedly, performance has rebounded strongly this year on the back of Global Central Bank liquidity provisions and the strong support of the Bank of England's Corporate Bond purchase program. The recent market dislocation in the first quarter really created a great opportunity for investors, especially if they allocated at the end of March – spreads have retraced somewhat but not to pre-Covid levels, so there is still value in this market.
Also, interest rates are extremely low and are not expected to increase any time soon. Cash rates are close to zero, so on that basis Sterling Corporates are an attractive asset class on an incremental yield basis.
Q. What about allocating to Global Corporates rather than Sterling Corporates?
Firstly, whilst many investors may not be aware of this, the Sterling Corporate market is global in nature. More than half of the issuers in this market are international companies, and many of the UK issuers are companies with regional or global footprints (for example one of the largest sterling issuers is EDF – the French energy company). Secondly, this broad nature results in a market that is linked more to global rather than to local news and risks. Thirdly, the sterling corporate market has offered historically higher yields and returns than those found in Euro or US dollar corporate markets.
We believe that HSBC's strong expertise in credit with a team of over 45 credit analysts based around the globe, has the resources and approach that would likely add value in a sterling corporate portfolio. Our global approach gives us an information advantage by having analysts closer to the companies they cover and to the news flows.
Q. How should Sterling Corporates be viewed on an asset allocation basis?
Really this is top down investing, with investors relying on the skills of a professional specialist manager to provide their bottom-up expertise. I rely on my large credit team for ideas – but this is a balancing act between risk and return, and security selection is key.
I believe that a Sterling Corporate manager should focus on exactly that rather than trying to game returns by allocating to High-Yield, Emerging Markets and or Securitised Credit. Those managers who had sizable esoteric allocations during the recent crisis would have suffered larger drawdowns than those of us who are more pure-play Sterling Corporate managers by nature.
Sterling Corporates should be a core bond allocation for any UK investor. This provides a steady, reliable income stream and potential for capital growth. Predominately investment grade in nature this can offer a higher expected return than government bonds – with the reward coming from the extra credit risk undertaken.
Overall, given the global nature of the Sterling Corporate market, investors can achieve good diversification, benefit from a higher yield and keep a low exposure to idiosyncratic UK-related risk by staying invested in Sterling Corporates with no obvious benefits from moving towards global credit strategies.
Q. What are the risks that investors are concerned about and should be aware of?
Investors are concerned about risks such as Brexit or indeed what happens if there is a second Covid-19 wave. We are clearly cognisant of these issues and have made moves to protect our client's portfolios, firstly in the short-term by reducing exposure to REITS and Retail – areas where behaviour has fundamentally changed – such as shifting consumers shopping habits, and in the longer-term by reducing exposure to Banks, in case the economy experiences a deeper recession. Equally, we have increased our exposure to defensive sectors such as Telecommunications and Utilities, where we still see value and which would be more protected from a second Covid-19 wave and a deeper recession.
Equally, whilst central bank actions have been supportive for the market – the market momentum itself has been generated by liquidity and not fundamentals – we could quite easily see tighter spreads even as corporate credit quality deteriorates. The support given to the corporate market by the Bank of England's QE programme and their willingness to continue to do so, gives substantial downside protection to the market should the above risks materialise.
Q. Where and how are investors allocating?
Corporate debt in general has continued to see inflows in Europe, with active funds capturing the bulk of these flows as investors look to navigate the effects of Covid-19.
To date, UK retail investors have shown a preference for Global Corporates instead of Sterling Corporates. Brexit uncertainty is very likely to be behind this trend, as investors logically want to protect their portfolios from this perceived risk. Yet institutional investors have been adding in Sterling Corporates, as there is extra value in this market offering a higher spread versus US and EU corporates. Additionally, as Gilt yields approach zero, there has been an increase in interest from investors who have large Gilt holdings to move into credit to achieve higher returns. Pension schemes who are in a position to de-risk their investment portfolios, continue to move out of equities into long dated credit in order to match liabilities.
Whilst I have sympathy for investors gaining their equities exposure via passives vehicles, the case remains very compelling for an active allocation within Sterling Corporates. Passive fixed income is harder to replicate and requires investment in more indebted companies as they are more likely to have larger amounts of bonds outstanding. An active manager can avoid this trap as it is clearly not prudent to invest in highly indebted companies. Asset managers that have a large global credit research team with sufficient resources to analyse the large number of issuers in the Sterling Corporate market, are better placed to generate added value to their portfolios and so outperform those investing solely in index funds.
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