We asked Fidelity's Sajiv Vaid and Peter Khan about their strategy for extracting value from both investment grade and high yield bonds
Political and macroeconomic uncertainties continue to cloud the outlook for global financial markets. With growth anaemic and interest rates anchored at low levels, how are the managers of a sterling-focused fixed income fund positioned to keep delivering the stable income investors want?
The fund is Fidelity Extra Income, one in a suite of core fixed income products in Fidelity's diverse product range. The £617m fund celebrated its 20-year anniversary last year and today is managed by Sajiv Vaid and Peter Khan - two seasoned investors with over 50 years of experience in global fixed income markets.
Fidelity Extra Income began life as a response to sophisticated investor demand for a higher income version of the group's highly successful Fidelity MoneyBuilder Income vehicle, allowing for slightly more credit risk. The aim of the portfolio is to deliver an attractive level of income, extracting the best value from investment grade and high yield bonds whilst not losing sight of the core attributes investors look for from their bond portfolios: an attractive level of income, low volatility and diversification away from equities.
The result was a portfolio with a typical split of 60% investment grade credit and 40% high yield which could look across the credit spectrum in search of long-term risk-adjusted returns. This unique approach that the Extra Income Fund takes, investing across the credit spectrum, allows the team to take a more holistic view of credits. Vaid suggests the fund was ahead of its time in that it was really a prototype strategic bond fund before they became fashionable.
The risk-adjusted element is a crucial tenet of the Extra Income Fund, and the managers are explicit that this is not an ‘income at all costs' fund. Whilst this is a credit focused strategy, the team also use duration at the margin to help to balance the risk in the fund.
"We don't always have an answer to the economic and political uncertainty facing the UK," says Khan. "We are serving a Sterling-domiciled investor base so we can have confidence in holding high quality Sterling credits, but we remain selective. In line with investor expectations, Extra Income will tend to have more idiosyncratic Sterling risk than other portfolios so that is why it makes sense to offset some of that risk with duration exposure."
Alert to panic-sold value
The hallmark of the fund since its inception has been its active approach in investing across the credit spectrum in order to deliver an attractive risk-adjusted income, rather than simply "yield at all costs".
A good example of this was an investment in bonds issued by Tesco. Around five years ago, Tesco was a key holding for the fund, and the team cut the position after a credit analyst raised concerns on weak business performance putting pressure on the company's ability to retain its investment grade rating.
Tesco bonds were later downgraded to high yield and given the fund can invest across the credit spectrum, the downgrade meant the team were not forced sellers at potentially stressful prices. After the downgrade, the team topped up the holding seeing value once again and 2019 saw Fitch upgrade Tesco back to investment grade. As Khan explains, "being able to identify things other portfolios wouldn't necessarily be able to take advantage of gives us a competitive edge, especially in the crossover space."
This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. The ideas and conclusions here do not necessarily reflect the views of Fidelity's portfolio managers and are for general interest only. The value of investments and the income from them can go down as well as up and clients may get back less than they invest. Past performance is not a reliable indicator of future returns. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the Fund investing in them. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investments in Fidelity funds should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0120/23529b/SSO/NA