Milburn uses six sources of alpha to reach top quartile
Aegon manager combines top-down and bottom-up approach to navigate High Yield Bond vehicle to top-quartile status since taking over in 2003.
Fixed income manager Philip Milburn has steered the £248m Aegon High Yield Bond fund to top-quartile performance since he took over the fund in 2003.
The fund is ranked fourth out of 16 vehicles in the IMA £ High Yield sector over five years to 21 June, up 28% compared to a sector average increase of 22.6%.
Over one year the fund is ranked fifth out of 20 vehicles, up 33.3% compared to an average of 25.9%.
Milburn has also managed the Ethical Corporate Bond fund since May 2002. Over one year the £182m portfolio is up 26.8% compared to an average peer group increase of 18.1%. It sits in the IMA £ Corporate Bond sector.
He co-manages Strategic Bond with David Roberts. Over one year, the £313m fund is up 24.9%. It sits in the IMA £ Strategic Bond sector.
How would you describe your investment process?
We are great believers in running portfolios rather than just collections of bonds. Our process has six sources of alpha. Three are top-down – asset allocation, duration and yield curve – and three are bottom-up – ratings allocation, sector allocation and stock selection.
We have a formal monthly strategy meeting setting out the top-down strategy framework, and the bottom-up we do on a day-to-day basis. We have teams of people who are specialists in each area, and it is up to generalists like me to extract the best we can out of these specialists.
The biggest drivers for the Strategic Bond fund are asset allocation and duration, which varies through the cycle, but it is an aggressive asset allocating vehicle. It will go from investment grade to high yield to government bonds. It is one of the oldest strategic bond funds in the market. Strategic bond funds are the current fad, but we have been running one since December 2003. It is relatively concentrated with around 80 holdings and invests in the best global ideas, both macro and micro.
The majority of the alpha for the High Yield fund comes from pure stock selection – it is a stockpicking fund. At the margin, we can do a little asset allocation, whether or not to be a bit more defensive and hold cash. But the majority of the outperformance will come from hopefully getting the right stocks and, even more importantly, avoiding the wrong stocks, given the nature of the high yield market.
The Ethical Corporate Bond fund is like a normal corporate bond fund but with a dark green ethical screen first. In this fund, the biggest drivers are three-fold: sector selection, where the fund has natural and deliberate biases towards financials, duration management, and stock selection.
What are the reasons for High Yield Bond’s strong performance over the last year?
I ran a cash balance through the summer of 2008 when things were looking pretty ropey. Then when Lehmans went bust in 2008, I spent this cash balance when yields reached 20% and I thought they were discounting the end of the financial world. I was premature to invest in September in the high yield market, which bottomed in March 2009. But fortunately I was still cashflow-positive, and continued to buy more through the dip.
At the start of March 2009, which was the beginning of the bull market in credit, the fund was running fully invested compared to peers, who had taken a lot more of a defensive stance. The biggest benefit through to May and June 2009 was being fully invested. It may sound odd – a high yield fund buying high yield bonds – but so many people had retreated into their defensive bunker.
Also in the downturn, I picked up some of the deeply beaten-up financials at ridiculously low prices – only in small size, but given they rallied so much, this was a good benefit. Then the next layer down was stock selection as I continued to sweat the assets.
What changes have you made to the portfolio in recent months?
I have been reducing financials as the companies have been bidding for their own bonds, so I have been taking profits in financials. The bank’s weighting in the fund is down to just over 10%. This is good because I want the core of the fund to be traditional high yield investment, and the banks were really just adding a bit of spice a year ago.
The other change is, for the first four months of this year, the high yield market rallied. In that rally, we took a bit of profit on some bonds. In hindsight, we should have taken more profit, but ever since this wobble, caused by the peripheral-Europe Piigs crisis, we have been running cash fully invested. Any other change is just at the stock level while continuing to churn out the results.
It is worth pointing out at the stock level we have a few natural biases. I continue to prefer less cyclicality in the credits we buy – more defensive credits, which are able to cope with their debt through the cycle. In the previous bull market, there were some companies getting debt on the balance sheet who really should not. A good example is semi-conductor companies, which should not have any debt on the balance sheet. They should be net cash through the cycle.
Auto-makers, airlines and chemicals are other areas we choose to avoid. I prefer bonds from gaming or cable companies, which have a good recurring revenue base and therefore a relatively predictable revenue stream. They still produce fewer profits in a downturn, but the effects are far more cushioned than with highly cyclical, operationally leveraged companies.
Do you think investors should still be looking at bond funds?
They are a diversification out of equities. They are by definition lower beta than equities, and are better at providing some capital stability.
Admittedly, 2008 and 2009 saw more volatility in credit markets than we have ever seen before. However, in general the natural regression to the mean of the credit markets means long-term expected returns for investment grade will be mid-single-digit, and for high yield, high single-digit, and they make up a good part of a portfolio. Obviously for the Strategic Bond fund, if you get the timing right you should be able to achieve more than this through the cycle. Investors have to be realistic about expected returns. The 30%, 40%, 50% returns from some bond funds last year are not going to happen again, but mid to high single-digits is achievable for most bond funds on an ongoing basis.
