Investec UK’s head of fixed income, John Stopford, discusses the outlook for credit
John Stopford is Investec Asset Management’s UK head of fixed income, managing a team of 26 people and running a number of funds including Investec’s £132m Global Bond and £237m Sterling Bond, set to be renamed Strategic Bond next month. He also co-manages the £180m Investec High Monthly Income fund, listed in the IMA £ High Yield sector.
Global Bond is ranked second out of 46 vehicles in the IMA Global Bond sector over three years to 1 June, up 71.7% compared to an average increase of 40.7%, according to Morningstar.
How would you describe your investment process?
We look at the economic drivers of markets and market price behaviour, including the factors which cause markets to be misvalued in the first place, such as investor sentiment and positioning.
Once we have made our asset allocation decisions, we look to add value through selection within bond markets. If we are allocating to credit, we look to pick corporate bonds which stack up on our approach, including valuations, fundamentals and market price behaviour.
In the case of interest rate exposure, we look to take active duration positions, active relative value positions across and within countries, such as yield curve positions. Where we can, we will take active currency exposure.
So the style is a combination of value-based top down and also looking for the opportunities from the bottom up.
What are the reasons for such strong funds performance over three years?
We have a good understanding of risk and return. Over the last few years, understanding where you are in the business cycle and what offers value at any point in the cycle has been quite important. Being defensive in credit going into difficult economic times, and being underweight credit and overweight government bonds and more defensive assets was a good thing to be during the downturn in 2007 and into 2008 in the credit crisis. We identified during the credit crisis that the markets were incredibly cheaply priced in terms of credit risk.
We took advantage of this by adding to corporate bond and emerging markets exposure.
What shifts have you made to holdings in recent months?
We have reduced exposure to credit, but also within credit by moving out of some of the more cyclical names. We had taken quite a large position in banks last year, and we took profits on this earlier this year.
We are still in an economic recovery, and interest rates will remain low, which should support flows into high yielding assets, and valuations at this point in the cycle still look reasonable. So everything in our asset allocation process suggests we should be overweight. It is just that we should be less overweight now than we were nine to 12 months ago, given how much spreads have come in and how much of the rally has already happened. We think we have still got more of the rally to go over the next 12 months. Typically a credit bull market lasts anywhere from two to four years, so we are only part of the way through it.
Within the Sterling Bond fund we have kept a moderate allocation because it has a smaller allocation within the risk budget. Within the Global Bond fund, we have a more reasonable allocation to emerging market debt, which is a great structural opportunity. Emerging market sovereigns typically look a lot sounder than many developed market sovereigns now, and yet you are paid a decent yield premium in both real and nominal terms.
How will the funds develop in the next year?
There is a lot of opportunity, in particular the weakness we have seen in the last month or so potentially gives the credit market a bit of a second wind. We do not think we are about to go into a double-dip recession. On this basis credit now looks pretty cheap. Our fair value models for high-yield corporate bonds suggests they have scope to rally about 300 basis points over the balance of this year.
This would imply quite decent absolute returns. Investment grade corporate bonds proportionately can also rally significantly but obviously they are lower yielding and less volatile, but in proportion to their risk they look attractive. Within local emerging markets the big opportunity potentially is on the currency side where a number of emerging currencies look oversold, so the scope to benefit from this looks pretty good. We will also be trying to avoid too much negative impact from rising government bond yields if this also happens over the balance of the year, as we expect. In which case selling futures to protect the returns on corporate bonds looks quite attractive as well. We think the returns can be pretty decent.
