Fixed income investors need to begin adapting their definition of risk, according to EdenTree's David Katimbo-Mugwanya, who said the potential for a second coronavirus wave and subsequent falls in credit quality has made for a "challenging" environment to invest for capital preservation while maintaining income.
As such, the co-manager of the EdenTree Higher Income, Amity Bond and Amity Short-Dated Bond funds, said the portfolios' durations are "as low as they have ever been", and he has increased weightings to defensive sectors such as utilities and consumer staples.
"In the big March sell-off, we took an opportunistic stance as spreads widened considerably - we used that to add to AA-rated credits such as Nestle, which, for two-year paper, saw its yield become as high as 2%," he said.
"We have definitely been taking opportunities in the high-quality space, rather than the lower quality holdings. In terms of Covid, I do not believe we are out of the woods yet, so we are really positioning in defensive areas where cashflows are more dependable."
Katimbo-Mugwanya said markets are reluctant to price in a second wave and the impact of a potential second lockdown, because whether the UK Government would be able to once more fund job retention and business loan schemes is "a tough question to answer," he explained.
"Unemployment is beginning to crystallise and the furlough scheme is ending in the UK, while in the US, payment protection programmes are ending.
"There has been a bounce in growth in the PMI numbers out of the UK and Europe but you would expect that given that a lot of activity that was postponed has come back."
While the manager believes a fall in credit quality could therefore be likely, he said the Short Dated Amity Bond fund is well positioned to avoid any so-called ‘fallen angels', given just 16% of the portfolio is invested in BBB-rated bonds.
"Yes, there have been downgrades from the BBB space, but we would like to think we have positioned the portfolio for quality - not just by credit ratings - but by the nature of the businesses we are investing in," Katimbo-Mugwanya continued.
"The portfolio itself is overweight utilities; these are cashflows that will not suddenly disappear because they are contractual.
"There is a chance that the BBB bucket of the fund could expand. But we have the flexibility to hold onto these names without being forced sellers because our portfolio is positioned on the defensive end of the spectrum."