manager of the M&G corporate bond fund opts for a 32% and 39% weighting respectively in A and BBB-rated bonds
A continued flow of capital from pension funds and investors shying away from equity volatility, combined with continuing low inflation, is the core scenario for Anna Lees-Jones, manager of the M&G Corporate Bond fund. Lees-Jones has been at the helm of the £1.3bn portfolio since May 2000 and is bullish on the prospects for the UK corporate bond market.
Is there a bull market in UK corporate bonds?
Yes. There has been quite a lot of realignment into the corporate bond market. There is much demand from pension funds, insurance companies and retail funds, which have realised through equity volatility their funds might not have been appropriately invested, which I think is a strategic move. There have probably been some more tactical flows. People have cashed in funds but haven't wanted to invest in equities yet so they've put their money in bonds for the shorter term.
Despite this, there is a fundamental long-term strategic move as well. There are quite a few pension funds on the institutional side of the business that want to switch into the bond market.
What is your sector split?
We have 5.5% in gilts and 2.5% in cash. We have nothing in supranational lenders. In UK corporates, we believe AAA bonds have no value worth speaking of. Some 26% of the portfolio is in financials, mostly UK retail banking as I don't like many European banking groups, especially not insurance.
Some 12% of the portfolio is in asset-backed securities, across a mix of industries. Some 10% is in property, although not in London offices, 5% is in telecoms, reduced from nearer 10% earlier in the year, and 11% is in utilities, which offer good value in certain parts of the sector.
We have 23% in industrials, which covers all sorts of companies from supermarkets to tobacco, while 5% is in high yield, which is my limit.
What is your view on UK interest rates?
Going forward, there is pressure to cut rates. The US has already cut rates and Europe is much more likely to reduce them than the UK.
House price inflation in the UK and pressure on public sector wages may be holding back the impetus for more cuts. I would say there is a 20%-30% chance we will see rates being cut within the next couple of months but my main scenario is that they will stay on hold for a year.
How do US interest rate movements affect UK corporate bonds?
The UK gilt market follows the US Treasury market, so the recent US cut will have an impact on gilts. Clearly, investment-grade corporate bonds are priced over gilts so that will have an impact on the pricing of the corporate bond as well. It seems a long way away but it does actually go through and have an effect.
How do you deal with liquidity in such a large fund?
What we have done is put in place three dedicated corporate dealers so I do not spend my day chasing round to get different quotes on bid and offers.
We probably deal about £50m a day, on average, which is enormous in a market that is supposed to be liquid. We can do this because of the size of the group and the resources we have.
Where are you in the risk scale?
The fund emphasises A and BBB so I only have 6% in AAA and 10% in AA. Some 32% is in A and 39% in BBB.
There is also a portion in non-rated bonds. We rate these ourselves and, on average, they are A and BBB. I have 123 different credits, which is made up by about 160 different issues.
The best risk-related return is in the A and BBB grades. In the past six months, we have seen AAAs outperform As and BBBs but that is partly on a safe haven status as we have seen equity market volatility.
Volatility has been priced into the corporate bond market and the AAAs and gilts have outperformed. But over the longer term, I still believe A and BBBs will give the best rate of return.
Have credit rating agencies been exposed as being poor?
There has been a lot of bad press on the rating agencies. We tell them regularly where we think they're doing well and where we think they're doing things badly. The main thing that we say is that we just want rating agencies to rate companies the way they always did, independently and consistently.
So what are their failings?
We only really get upset when there are inconsistencies across sectors or geographical areas and when the ratings change rapidly, especially when the only thing that has changed is that the bond or equity price, or both, has come under pressure.
If a company has a liquidity problem and requires a large refinancing in the next few weeks or months, the prices in the equity or bond market are clearly relevant, whereas if there is no liquidity issue for the next five years, the current pricing in the market is not much of a concern.
The rating agencies have been under a lot more pressure this year because they have had a lot of investment-grade defaults ' about 11 in the past couple of years compared to the typical 10 in a decade.
They have been looking at themselves quite hard and talking to us and other investors to get our opinions.
What are their strengths?
We have never relied strongly on what they have said but we do like talking to them about where they are coming from, what they think and what changes of opinion they have.
Even if we are not looking at their actual rating results and buying bonds just on the back of that, we have to be aware the market in general will always take notice of what the rating changes are.
Why should an intermediary buy into this fund?
Because it provides a good income and gives considerably more yield than a gilt fund would do but without the same level of risk.
We think the extra yield compensates for the slight increase in the risk. It is a very steady fund. It is not trying to do anything amazing, it is just trying to give good, steady total returns over each year.
How different is running this fund from your past experience?
It is obviously larger than funds I ran before but I used to run several funds that totalled around £3.5bn. The good thing about my position here is the back-up and the team. We have a large credit analyst team who are career analysts with stacks of experience.
Can you give me your worst case and best case scenarios?
First the bull case. The continuation of low inflation accompanied by a pick-up of growth would allow companies to grow their profits. Funds also continue flowing into the asset class. This is my core scenario, although the pick-up in growth will not be marked. Growth is going to stay pretty low but I believe the flow of funds from pension funds and the like is still in place.
And the bear case?
Inflation picks up. If there is a big inflationary fear, bonds in general will suffer. It is not my core scenario.
FUND MANAGER: Anna Lees-Jones
She has been an associate member of the Institute of Investment Management and Research since 1997.
In 1996, she joined Dresdner RCM Global Investors where for three years she managed a range of sterling fixed interest funds with top quartile performance.
Lees-Jones began her career at CS First Boston as a research associate,1994-1996.
She graduated from Cambridge University with a BA in general engineering in 1992.
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