Anna Lees-Jones, manager of M&G's Corporate Bond fund, believes the asset class is well positioned to outperform gilts
Anna Lees-Jones has managed the £1.2bn M&G Corporate Bond fund since March 2000, taking over from Theo Zemek, who now heads the group's European funds operation.
Over five years to the end of August, the fund has delivered top-quartile performance, posting growth of 56.28% bid to bid, compared to a UK corporate bond sector average of 46.91%.
Lees-Jones is bullish about the outlook for corporate bonds, believing the asset class is well positioned to outperform gilts but at a much lower level of volatility than equities.
The M&G Corporate Bond fund invests predominantly in investment grade corporate bonds, taking a maximum 3% holding in any one company. Given the size of the fund, the largest in its sector, Lees-Jones currently has more than 120 holdings to mitigate stock-specific risk and ensure that the portfolio is diversified.
The fund is one of 10 fixed interest retail vehicles managed by M&G and Lees-Jones is able to benefit from the support provided by the house's large and experienced fixed interest analyst team.
How much reliance is there among fixed interest teams upon the work of the ratings agencies?
I listen to them an awful lot but I also take an objective view. They may have knowledge we do not and they are very good on industry themes, which you can tap into, but their job is to look at the likelihood of default. What we are doing is looking at performance. The two are linked but not the same.
We look at questions such as, is a company likely to be taken over and, if so, is that good or bad for it?
Or, whether a company has an aggressive takeover strategy and how will they pay for it, through cash or debt? It is not in the rating agencies' remit to cover this.
Does the size of the fund make it difficult to manage?
The fund is one of the largest in its sector and we have had positive inflows this year so it is getting larger. The style in which we manage the fund is quite slow moving. We are taking decisions that will lead to first-quartile performance over the longer term.
The advantage of the size outweighs the disadvantages because we get better allocations and greater transparency with broker books. We can also try to influence new issues because we have so many funds.
How can you influence new bond issuances?
If we think there is a particular risk in a bond we can demand a covenant to cover that issue. Either the bond will tend to be borrowed at a wider level, which hurts the company, making the cost of borrowing higher, or we will put a covenant in which enables them to retain flexibility. It reassures investors.
What do you look for in a covenant?
The latest trend has been to have ratings-linked covenants. So, if, for example, a telecom company is downgraded to triple B, you get an extra 25 basis points per ratings agency that has downgraded them.
The other way is to pick financial cover. Typically you want a combination of cover but it can become quite complex. Ratings-linked covenants are clearer but it puts more responsibility on the agencies and there is debate whether they want this added responsibility.
Other covenants that are very often used and relevant include cover against a change of control or business strategy. We are just trying to get protection so we do not invest in a company that has a changing risk profile.
How watertight are covenants?
There are often ways lawyers can get around covenants if they do financial ratios or manipulate the figures. Ratings-linked are more secure in that respect.
Companies do not want to do anything to lose their investor base, however, and most want the flexibility to be able to issue again. If it is a straightforward issuance with no covenant, a company can just choose what is the cheapest and best for them.
What type of corporate debt does the fund primarily invest in?
The fund mainly invests in single A and triple B-rated paper but we also have some triple A and double A exposure and a little bit of high yield, up to 5%, to give a bit more diversity.
If you look at single A-rated bonds relative to triple A and double A-rated bonds, the yields are higher but the risk of default is only about 30 basis points higher. Historically, a lot of single A-rated bond issuers have been upgraded.
How do you choose which companies to invest in?
It is a combination of things: the macroeconomic background, the sector background, where you think the overall credit rating for the sector is going and stock-specific factors.
I have come from a gilt background so I still look at the fund from a top-down perspective in combination with the analyst coverage of individual companies. My job is to balance all of that.
The yield curve, stock and duration are the main factors I am trying to pull together.
Are you preferring longer or shorter duration bonds at the moment?
I prefer shorter-dated industrials because of the event risk last summer but I have lengthened out my exposure a bit in the past month.
Corporate bonds are 80% to 90% correlated with gilts and gilts are 100% correlated with interest rates. We are trying to take a long-term view on duration and this is key to performance. I have been moderately bullish and started to cut this back but I do not want to move the duration around that quickly.
While yield is the priority, are you always looking to gain capital growth too?
We actively try to do that but in a small way. If you get a little bit of capital growth it adds to performance over the longer term.
Spreads on corporates versus gilts are going to narrow but you only take advantage of that if you sell the bond. We are looking to avoid those stocks that we do not think are going to do so well, which goes back to credit research. We do that through in-depth fundamental analysis and a risk/return trade off.
What high yield exposure do you have at present?
About 4% of the fund is currently in high yield and includes names like Energis and William Hill, which is a single B bond.
Then we have a couple of double B subordinated tranches of securitised bonds. Companies like British Land and Sainsbury's have securitised their property and the deals initially come at very high levels, 400 basis points over gilts, when triple B bonds are normally priced at 200 basis points over gilts. People were not familiar with securitised bonds so were overcompensated.
Things have moved on, though, and people are more confident. Those spreads have come in quite considerably and they are now around the 270 to 300 basis points over gilts level.
The fund is also allowed to invest in non-equity priced convertibles but I do not currently have any. When options start pricing in the equity, we would be a forced seller anyway.
Securitised deals still sound attractive. Is that an asset class you will continue to invest in?
Each issue has to be looked at individually ' you cannot assume they are an asset class. If a company has a bad year or quarter, it can affect its ability to pay the coupon.
The deals are highly leveraged and it is more of a financial risk than a business risk and there is less flexibility within the structure.
You get more rights to assets if things go wrong and there are trigger points where you can demand consultants are brought in and so forth.
With these sorts of deals, we do not tend to have huge holdings and they do tend to be more illiquid.
We keep hearing that default rates are rising. How do you avoid these bonds?
When statistics show the default risk is rising it tends to be based more on the US and high yield, which has little correlation with what I am doing. In the US, they are seeing defaults particularly from technology and telecom companies and very little in the way of recovery.
European default rates are rising but that is among high yield rather than investment grade bonds. The telecom companies I am investing in have a lot of assets they can sell, which really is a different ball game.
FUND MANAGER: Anna Lees-Jones
• Anna Lees-Jones joined M&G in 1999 from Dresdner RCM Global Investors where she ran a range of sterling fixed interest funds.
• Lees-Jones began her career at Credit Suisse First Boston as an analyst.
• She graduated from Cambridge University with a BA Hons in General Engineering.
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