Investment company managers in the loans and bonds sector are using a range of tools to protect against rising inflation and interest rates, according to the Association of Investment Companies.
While the sector offers an average yield of 7.04%, total returns have been negative over one and three years, with losses of 7% and 1% respectively.
Rhys Davies, manager of Invesco Bond Income Plus, said of the market: “Inflation and higher interest rate expectations affect the whole bond market negatively but we think that at the current level of credit spreads and overall yield, an actively managed allocation to high yield bonds offers an attractive opportunity for income and total return.
“Whilst inflation data remains elevated, markets have effectively priced in a series of hikes from major central banks. Inflation data will continue to be the key focus for markets and likewise, if there were to be any surprises to the downside, markets are likely to react positively.”
In response to the ongoing uncertainty, some investment companies are taking steps including shortening duration in their portfolios and increasing exposure to floating rate debt to protect their portfolios, while others are taking advantage of their close-ended structure to deploy gearing and invest in less liquid debt or loans.
Simon Matthews, senior portfolio manager of NB Global Monthly Income, said: “The much lower duration profile of floating rate loans allows the fund to manage interest rate risk effectively. Senior floating rate loans with a duration of around 0.25, act as a low-cost hedge against inflation and as interest rates rise, coupons float higher. Around two thirds of NBMI is allocated to floating rate loans.”
Managers said the advantage of investing in loans/bonds using the closed-ended investment structure in highly volatile times is that the more liquid parts of the portfolio do not need to be sold to fund redemptions.
Adam English, manager of M&G Credit Income, said: “A closed-ended investment company structure allows us to invest in private and less liquid loans and hold them to maturity. Open-ended funds, on the other hand, can sometimes be forced to sell assets to manage client outflows. Investors in closed-ended companies can still retain access to their capital by buying and selling the company’s publicly listed shares.”
Matthews noted: “One of the key advantages to investing in loans and high yield corporate bonds within a closed-end investment company is not having to manage outflows and to be able to invest in alternative credit which also provides an opportunity to pick up yield with lower mark-to-market volatility risk.”
Looking ahead, managers said geopolitics will continue to drive inflationary pressure on material input prices and while central banks will use interest rates to try to stem rising inflation, it may take 18 months to really have an effect.
Ian Francis, manager of CQS New City High Yield, said: “There is increasing risk from wage inflation as the workforce tries to get wage settlements close to or above inflation in order to remain solvent.This is not due to greed but necessity brought on by the very high rates of inflation in domestic fuel and food. Credit risk has increased dramatically, particularly over the last six months making refinancing of company debt more expensive than it has been for a long time. Add to this the outflows seen from bond funds and it is logical to see difficult times ahead.”
Gary Kirk, portfolio manager of TwentyFour Select Monthly Income Fund, commented: “Corporates have been extremely proactive over recent years, taking advantage of ultra-low rates, hence refinancing over the medium term is very low and the liquidity on balance sheets looks particularly healthy. In addition, bank balance sheets appear extremely robust with excess buffer capital.
“Taking this into consideration we think it is fair to assume that the default rate will remain relatively low. In addition, and assuming our relative value and due diligence process will minimise the risk of default, then I would say the greatest risk facing our investors would be the mark-to-market volatility from any broad changes in investor sentiment.”
