The UK credit market is among the most enticing options for developed market fixed income investors, according to Aviva Investors’ James Vokins.
At the start of this year the manager halved exposure to US credit in the £566m Aviva Investors Strategic Bond fund from 20 per cent to 10 per cent following several technical issues.
While many strategic bond investors have been positive on the US market, Vokins – who runs the fund with Chris Higham – took down the fund’s exposure.
But where do you go if you sell your US fixed income? The manager said there is still not a great deal of value by going back into Europe, with yields low and some in negative territory.
“Obviously yields are incredibly low there and it is not exactly a beacon of stability given what is going on with the Italian elections for example,” he explained.
As such, the fund has moved to an overweight position in UK debt, despite the uncertainty surrounding Brexit and the strong performance over recent years.
Performance of index over 10yrs
Source: FE Analytics
“There is a lot of uncertainty politically around the UK but what we feel about sterling investment grade is that it is the most globally exposed credit market out of all the developed markets,” Vokins said.
In the US, around 80 per cent of the credit market is from US domestic-focused corporates, meaning that investors are taking a large bet on the health of the US economy.
It is a similar story in Europe, where 75-80 per cent of the market is in European domestic-focused companies. In comparison, the UK credit market is made up of less than half of such companies.
“What we like about the UK market is you can get access to these huge, global, very strong and stable investment grade corporates that happen to be in sterling,” the Aviva Investors Strategic Bond fund manager said.
“It is not like you are completely exposed to the political concerns in the UK, you are investing in large global conglomerates that we like from a fundamental perspective.”
Additionally, while other markets have gone through unprecedented quantitative easing (QE) measures, there has been less interference in the UK.
“In the US the Fed is obviously going through the process of quantitative tightening and are reducing the size of their balance sheet by selling down bonds,” Vokins noted.
“In Europe they are tapering their bond purchases to a potential stop point later this year so there is quite a large concern of the quantitative overhand.
“In the UK we don’t have that. We have a smallish corporate bond component on the Bank of England’s balance sheet but it is not a major concern going forward and we think they will be very cautious in terms of rate hikes.”
Finally, he noted that UK, which makes up 45.1 per cent of the Aviva Investors Strategic Bond fund portfolio, is a more marginal market than the US.
Regional allocation of fund as at February 2018
Source: Aviva Investors
“When a big US corporate like Apple has to get some funding done it is not necessarily going to go to sterling if it is weak,” he said.
“Whereas in the US it will have to if it has debt that is coming up that needs funding right away. Even if the market is weak there is always going to be that supply pressure whereas in sterling it is a much smaller market.”
However, having reduced the weighting earlier this year, Vokins said the US credit market is becoming more interesting again.
Much of his concern at the time surrounded demand in the market drying up through a number of factors.
First was the increase in the issuance of T-Bills, a short-term debt obligation backed by the US Treasury with a maturity of less than one year.
Vokins said: “They have ramped that up recently and we’ve seen that put pressure on credit spreads because there has been a bit of this crowding out idea where those that would normally buy credit – because it is relatively safe but you can get an increase in yield – that demand has dried up because treasury yields are looking pretty attractive now.”
Secondly, the repatriation of earnings that many saw as a positive for the market as there was the potential for an increase in debt buybacks and deleveraging at the balance sheet level of US corporates, the manager considered a short-term phenomenon.
“These corporates – mainly in the technology sector – were large corporate bond owners. Obviously they issued debt but they also owned a lot of short-dated credit because they didn’t know what to do with this huge amount of cash on their balance sheet particularly as it was often trapped overseas,” Volkins said.
“That is another area that has dried up because as soon as you allow these corporates to bring money back into the US they don’t need to buy corporate bonds anymore.”
The third and final concern was that a large swathe of inflows into the market had come from foreign investment with European and Asian managers targeting the region because it is a deep, liquid market with a decent yield pick-up compared to the rest of the world.
“We have seen huge growth in that overseas demand and at the beginning of the year we were concerned that was drying up,” the Aviva manager said.
However, he said that these factors are merely technical rather than structural, with reasons for optimism on all three fronts.
“I still think the US is an interesting place to look now yields are markedly higher,” Vokins said.
As such, while the management team reduced exposure in the Aviva Investors Strategic Bond fund at the start of the year, they are now looking to redeploy when new, interesting corporate bonds come available.
“We are not running for the hills. There are a lot of technicals that are causing this area of the fixed income market to spike but we think that that’s going to be relatively short-lived and nothing is flashing red to us to show there is a fundamental change going on in US corporates,” he said.
Vokins joined the Aviva Investors Strategic Bond fund in June 2016, during which time it has returned 6.42 per cent – 1.65 percentage points below the IA Sterling Strategic Bond sector average.
Performance of fund vs sector since launch
Source: FE Analytics
Co-manager Chris Higham has run the fund since its launch in 2008 however, during which time the fund has returned 108.13 per cent – a top quartile return.
The fund has a yield of 3.3 per cent and a clean ongoing charges figure (OCF) of 0.63 per cent.