AAA-rated fund manager Michael Markham took over running Investec's Sterling Bond unit trust in February this year
Since joining Investec from Invesco Perpetual in February this year, Michael Markham has taken over as manager of the Investec Sterling Bond unit trust, which invests primarily in high quality corporate debt, aiming to produce total return.
Markham, who also manages the Investec Global High Income and European Bond unit trusts, brings with him a strong reputation, having headed up Invesco's GT High Yield and co-managed the Invesco GT European High Yield funds, earning him an AAA rating from Standard & Poor's.
He has joined a well resourced fixed interest team at Investec, headed up by Paul Griffiths, who moved to the group from Invesco in June last year, also having headed an AAA-rated fund.
Despite being Markham's direct superior as head of the Investec fixed interest team, Griffiths is Markham's number two on the Sterling Bond fund and provides the direction for the gilt element of the portfolio.
What is the aim of the Sterling Bond fund?
It is a Pepable and Isable fund so, while we have some gilts to manage the duration effectively, typically between 10% and 20% of the fund, it is predominantly a very high quality sterling denominated investment grade fund. It is not a gilt fund.
What is the split between the different levels of investment grade bonds that you hold?
This fund only invests in investment grade debt. It does not invest in non-investment grade debt at all. That is by design. We are doing exactly what it says on the tin.
We take it a step further and don't allow more than 20% of the fund in BBB-rated securities to cap ourselves further. More than 50% of the fund will always be in AAA and AA securities. The current breakdown is 37% in AAA-graded securities, 29% in AA, 28% in A and 2% in BBB.
The remainder of the fund is invested in cash or bonds in which the issuer is not rated. That gives an average credit quality of AA.
What percentage is currently in Government debt?
Around 14% is currently in Government debt, which is typical. It reflects a neutral stance and the fact we think that in investment grade sterling credit, there are still some very good opportunities with continued institutional demand through the well-worn arguments of the Minimum Funding Requirement.
The gilt market is considerably more liquid than investment grade sterling bonds. That is not to say liquidity for investment grade sterling bonds is poor, but if you want to enact duration management strategies, it is easier, and more cost-effective, to use the gilt market.
Consequently, when we feel we want to lengthen the duration profile of the fund, we will use the gilt holdings to enact that strategy, which obviously minimises dealing costs with lower bid offer spreads and allows the transaction to be carried out easily and quickly.
Equally, at times when we are pessimistic about capital values and feel we want to shorten the duration profile to protect capital value, we can enact that policy through the gilt holding, shortening down the yield curve with very short-dated gilts.
How are you positioned in the gilt portfolio currently?
We have a very short duration on the gilt holdings because we see very good value in the investment grade long-end of the sterling bond market. Therefore, the longest gilt we have is 2007. We are likely to shorten even further because there is a new AAA bond in sterling dated for 2030 for EDF Electricitie de France, on which we are quite positive. There are some good financial covenants to ensure that if it gets downgraded we can put it back, so we are effectively protected. It would be ideal for this fund.
What is the balance between the importance of stockpicking in the universe of corporate debt and the importance of formulating sector preferences?
Historically, people have spent far too long discussing he merit of Boots versus Tescos which, while it is obviously very important, misses the point that either retailers are a good place to be or they are not.
If you think the consumer cyclical or consumer non-cyclical sectors are where you need to take key core positions, and if you think the fundamentals of that sector will lead to added value, that is your primary call.
Obviously, in each sector there will be stocks with better competitive positions, or more efficient processes, but ultimately, we take sectoral positions and then pick stocks best placed in those sectors.
We do a significant amount of credit analysis at Investec because we have seen over the past six years that you can't just buy investment grade debt to give extra yield. We have seen significant volatility and corporate debt underperforming and investors have not been compensated by the additional yield.
What are the most significant sector positions in the corporate basket of debt?
Given the higher quality nature of the fund, we favour the higher quality bank paper. The profitability seems to be fairly robust, although we have to make sure that if we do get a sharper downturn in the US, it doesn't spill over into the UK.
At 22% of assets under management, we have got a significant proportion of the fund in this sector. That is spread across 10 stocks at around 2% each. We have significant exposure to the likes of RBS, Lloyds and Abbey National, a situation we are monitoring closely as is a likelihood of more corporate activity going forwards.
What other significant sector positions do you hold?
We have significant exposure to sovereigns and supernationals, namely non-gilt exposure. This way we can play what we see as a theme of institutional investors increasing their corporate bond weightings.
While some institutional investors will go down to A and BBB issuers, we feel there will be good value to be extracted from the likes of the high quality issuers.
If it is your first step out of gilts into corporate bonds, the natural place to go would be into the AAA and AA issuers, such as the World Bank or the European Investment Bank, although they haven't performed very well of late. We own both of them.
How are you positioned for utilities?
It is a sector we are not particularly keen on. We have about 13% of the portfolio invested in utilities, which is an underweight position compared to the Merrill Lynch Corporate Sterling Bond Index, although we focus on total return and are not particularly benchmark focused.
Our exposure is also very short term. We have a small position to BG Transco that is a long-dated position. With the exception of that, the longest position we have is 2006 in a water stock.
While we are comfortable with them on the shorter dates as the spreads are attractive and you get compensated for holding them, we are uncomfortable that the regulated businesses will not be able to continue to deliver the profitability and still support their debt levels as they try to increase return to shareholders.
What is the number of holdings you like to have in the portfolio?
Average positions of about 3% leads us to between 30 and 40 holdings, which we believe is consistent with maintaining diversification in corporate bonds.
That said, if we ended up with 20% in gilts it might only be in a couple of holdings and that might reduce the overall number slightly if we become very concerned about average levels of credit spreads.
Under Paul Griffiths there has been an increased focus on risk monitoring and scenario risk testing. Can you tell us why there is such a strong focus in this area?
Historically, investment managers have always paid lip service to risk analysis and risk control but it has been very much a question of after the fact. Only in retrospect have people looked at where they have added value and the risks they have taken on.
We feel that by actually spending time and resources you can integrate that analysis into your decision-making process. One aspect of that is constructing and testing risk scenarios for the portfolios managed by the fixed interest team.
That is why, rather than having a separate risk analysis group, Investec brought in risk analyst Shakeel Ahmad as an active member of the fixed interest team, where he can contribute to the investment process so we can use it before we invest rather than after.
We have taken on Wilshire Axiom as the system to help us take these decisions. We haven't quite got to the finished product but the goal is to get more out of the tools that are currently available.
How is the fixed interest team organised?
The fixed interest team, which has 15 fund managers, is split into small focused teams, each with full responsibility for their product area.
There is the global/single markets team, the credit/high yield team, which I head up, the cash and money market team, the emerging markets team and the risk control team. These meet weekly to review the economic assumptions and forecasts.
Can you run through the process by which you invest?
The process begins with an analysis of all the major global economies, from which a range of probable scenarios is generated. This uses quantative analysis and qualititive assessment of the likely direction of the major components of GDP, inflation and monetary and fiscal policy relative to consensus forecasts.
There is also input from the equity teams at this point. This is discussed at the monthly macroeconomic meeting, which provides a basic macroeconomic platform from which to generate a fair value range for the bond yield forecasts.
After this meeting, the decision-making process comes down to the small asset class teams that assess the compelling forces, the factors that underpin and drive each bond market, and construct portfolios.
What is the macroeconomic backdrop to the sterling corporate debt market?
Broadly speaking, we are a little concerned about the backdrop to investment grade and the gilt market is one of higher growth than the rest of the developed world, such as the US.
On a relative basis, we think the gilt market is one of the least attractive of the international bond markets but, that said, we are in a situation where we are not anticipating inflation going back to the levels we saw in 1990.
Consequently, we would look at any back-ups in gilt yields or falls in prices as an opportunity to lengthen the maturity profile and take advantage of what we see as a broadly positive backdrop for investment grade bonds, including the gilt market.
What will be the impact of changes to MFR? Can you invest for it?
The obvious consequence is that while there will be an increased focus on non-gilt, high quality, long-duration assets, that could be incorporated into pension funds, which includes investment grade sterling debt.
One of the reasons all our over 15-year exposure in the Sterling Bond fund is invested only in non-gilts is that we think ultimate additional demand will be forthcoming and is going to support the price relative to the gilt market. So, yes you can and we are invested for it.
How scaleable is the investment process in the fund?
In terms of the investment process, we have reached critical mass in terms of spending time and resources to do the credit work to invest the fund well and safely, but we are not such a large size that we are finding it difficult to get the amount of stock we require for investment. We could easily see this fund grow to £1bn and that would still be the situation. We would still be able to enact investment strategies.
The investment grade sterling bond market is continually increasing, both because there is demand and because there is supply from corporations looking at it as a way of financing their businesses.
FUND MANAGER: Michael Markham
Markham was educated at King College London where he graduated with a honours degree in mathematics in 1987.
He began his investment career in 1987 at GH Asset Management, now part of Aberdeen.
In 1993 he joined MGM Assurance, after a brief period at Capitol House.
He joined Invesco in 1996 to head up its corporate debt team.
In February this year, Markham joined Investec and, in June, became manager of the Sterling Bond fund.
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