Indiscriminate price falls across financial securities are creating compellingly attractive investment opportunities, according Rathbone’s Bryn Jones.
The threat of contagion to European banks caused by the sovereign debt crisis has led investors to flee to safer assets.
This morning the FTSE is down more than 1.5 per cent due in part to the concerns that the eurozone is going into meltdown.
Mike McCudden, head of retail derivatives at Interactive Investor says that the risks are leading to worrying levels of stress in the bond market.
“The fear is that Eurozone contagion will happen - but it is happening. It’s the threat of global contagion that’s on the cards now,” he said. “Credit markets are drying up as rising debt yields are spreading like cancer throughout Spain, Italy and Portugal, whose bond yields are hovering around the critical 7 per cent mark.”
He added: “Substantial ECB intervention is needed in the bond markets as soon as possible to stem the rot, or it may be a case of too little too late.”
However, Bryn Jones, manager of the Rathbone Ethical Bond and co-manager of the Rathbone Strategic Bond fund says that he is finding it difficult to understand why some of the continent’s leading financials are suffering.
“The debt crisis has raised the risk that banks will be unable to pay their coupons after accepting government bailouts and prices have fallen across the board. This is despite the fact that there are numerous banks and insurers that are nowhere near in danger of seeking government bailouts. Markets are treating all financials the same, irrespective of balance sheets.”
FE Trustnet reported last week that many corporate bond managers have fled to the relative safety of gilts despite the fact that these bonds will are paying negative real yields.
While the move seems to be a defensive one in reaction to fears that contagion could spread to banks and beyond, data from FE Analytics shows that the average Sterling Corporate Bond fund has 29.9 per cent in financials.
Jones is even more bullish. The Rathbone Ethical Bond fund has around 57 per cent invested in banks and insurers.
“Gilts are offering negative real yields and I’d find it hard to tell my investors that I’m happy to return less than inflation. On that basis, and a valuation basis, the risk is definitely worth it,” he said.
The manager says he can’t understand why the market is asking such high yields of high quality borrowers.
“Balance sheets are in great shape, many of these banks are still paying a dividend and are far removed from not paying out bond coupons. However, medium-term bonds in a bank like ANZ are paying upwards of 10 per cent. Yields should simply not be that high. We are finding great value there.”
Invesco Perpetual’s Paul Read, who runs a number of fixed income portfolios including the underperforming Invesco Perpetual Tactical Bond fund, said in October that he was sticking to a strategy which focused on quality financials.
“Our focus has been on big European banks that have a lot of franchise potential and demonstrated their ability to raise capital organically,” he said. “We’re focusing exclusively on really quite significant banks and not focusing at all on second-tier banks where there is risk of some impairment.”
According to our data, the Tactical Bond fund has lost 6.87 per cent over the last 12 months while the average Strategic Bond fund has returned 1.78 per cent. By comparison the Rathbone Ethical Bond fund has lost 0.63 per cent over the same period.
Performance of funds vs sectors over 1-yr
Source: FE Analytics
Adrian Lowcock, senior investment adviser at Bestinvest, says investors must look carefully at the underlying assets of a Corporate Bond fund before buying in this environment as there are numerous strategies being employed.
“Managers are holding either gilts or bank debt so you have a real mix of very low to very high risk being held. It is important to remember that bond funds might have very specific investment mandates so do not look at the whole market. In addition, some will have the bank debt and are unable to off load without incurring significant losses so have decided to hold onto it instead.”