With expectations that the UK economy will grow by just 2% in 2003, Threadneedle's Ted Bacon is rema...
With expectations that the UK economy will grow by just 2% in 2003, Threadneedle's Ted Bacon is remaining light on the high yield end of the UK bond market.
Bacon, fund manager of Threadneedle Strategic Bond, says in the run-up to Christmas he upped the portfolio's exposure to high yield as it was an environment of improving investor sentiment and encouraging trading statements.
The fund increased its weighting in high-yield debt from 30% to 40% through 2002. Still, Bacon is wary of going overweight high yield debt due to the remaining uncertainty in the market, including the possibility of war and insipid economic growth.
He says: 'The start of hostilities could see a knee-jerk move into lower risk assets, so it feels a bit early to go overweight in high yield just yet.'
The fund is also remaining neutral in terms of sector exposure, says Bacon, although he adds he does have some strong convictions. Within the financials sector the fund is underweight insurance and in the banking sector he prefers domestic UK players such as Barclays and Royal Bank of Scotland.
Bacon says: 'Of our very few foreign financial holdings, one of our favourites is Household of the US, the consumer finance company that has been taken over by HSBC. We didn't think the improved credit quality of the new parent was reflected in Household's bonds so we bought some in December. Since then the spread has narrowed by half a percent.'
Looking at the last quarter of 2002, stockbrokers Carr Shephards agrees a potential war is a threat to the UK bond market. The group also believes another barrier for UK fixed interest is the possibility the Government may fail to resist the combined claims of the public sector trade unions for wage demands well in advance of levels compatible with a low inflation economy.
Theo Zemek, bond manager at New Star, believes the lower end of the investment grade bond market and high end of the junk market are offering the most attractive opportunities at present. She says gilts when they were yielding 4.5% at the long end did not look attractive and now they are at 4.33% on the long side, they definitely do not look exciting. At the same time the upper grade corporates are looking extremely expensive, she notes, adding unless they are very short dated, they will suffer.
Zemek agrees with the general rationale behind why high yield debt looks attractive at the moment as companies work to strengthen their balance sheets so default risk is falling off.
However, on top of all that, she says the market has entered a period of prolonged debt reduction. 'We're in a situation now where the economy does not look at its most dire so a lot of these companies are working to repay their debt,' she says.
'This scenario is already being seen in the likes of Vivendi and Fiat, and we believe that the trend will continue.' While there will be new issuance in the market, most companies will find it hard to leverage themselves up any further so debt reduction will be the focus for some time, she adds.
Another positive for sub-investment grade paper was seen in the last week of January when equity markets plummeted but high yield stayed steady, showing high yield is decoupling from equities, Zemek says.
Companies focusing on repayment of debt.
High yield decoupling from equity markets.
UK domestic banks look attractive.
War continues to be a threat.
Gilts yieldong at unaatractive levels.
Economic growth remains insipid.
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