Move aims to give downside protection to capital at expense of headline income
Fidelity's high-yield fund is favouring distressed debt as a defensive play, a move designed to give downside protection to capital albeit at the expense of headline income.
The group is favouring distressed debt in the high yield arena as it believes many of the stocks expected to default may have more upside potential than downside.
Andrew Jenkins, group leader of fixed income at Fidelity International, said that expected default is priced into many of these bonds and they often trade below the liquidation value of the company.
He pointed out that NTL is priced as if it were about to default and is trading at a discount to the company's NAV.
He said that the downside potential is limited at this point although there is significant upside opportunity if there is good news for the issuing company.
Jenkins is taking this defensive stance as he believes there could be continued volatility in the high-yield corporate bond market going forward.
He added that distressed bonds do not tend to pay a coupon and that this may impact on yields offered by funds that invest in them. Fidelity Extra Income has around 5% invested in this type of issuance and is currently offering a gross running yield of 7.5% although this may fall on the back of the distressed debt exposure.
Fidelity Extra Income has an AA rating and is ranked 19 out of 33 in the UK Other Bond sector over one year to 13 February on a fall of 6.9%. The fund is 21 out of 39 over three months on a fall of 0.1%.
The group is also to step up its coverage of Far Eastern corporate bonds by moving two of its London bond team to Hong Kong to focus on this part of the market.
Andrew Wells goes to Hong Kong in July as group leader of fixed income Far East, while Gregor Carle is to relocate in April to head up fixed income research. Both Wells and Carle are already carrying out their roles but have yet to move out to the Far East permanently. Fidelity will also look to recruit analysts to increase its local coverage of Far Eastern bond markets.
Jenkins said the group runs Far Eastern bond mandates for institutional clients and is keen to improve its research by having investment staff on the ground in the Far East focusing on bonds.
In a separate move, Fidelity is launching an institutional UK corporate bond fund targeted at small and medium-sized pension schemes. The fund, called UK Long Corporate Bond, will be managed by Alex Veys and the targeted return will be 0.75% a year above the Merrill Lynch Over 10 Year Eurosterling Index over rolling three-year periods. The fund will invest in sterling non-gilt bonds including corporate and supranational issues. Veys will focus on issues with more than 10 years to maturity and with investment grades of BBB and higher.
Anna Roads, head of research and product development at the group, said: 'Demand for corporate bonds and in particular long corporate bonds, looks set to continue due to the increasing maturity of pension funds and issues such as FRS17. We believe this fund will help service this requirement for small and medium-sized pension schemes.'
Fidelity manages around £8bn in bonds and money market funds in the UK, of which around £1bn is in corporate bonds.
Roads added: 'As with all our bond funds, the process is driven by our bottom-up stock research undertaken by Fidelity's credit and quantitative analysts, who assist with the selection of individual bonds, sectors and yield curve positions. Duration will be kept very close to the benchmark and the fund will be managed to a full set of institutional risk controls.'
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