Fixed Income | Masterclass

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  • 40 mins 31 secs

Learning: Structured

In this Masterclass, Premier Miton’s fixed income team discuss the investment opportunities and challenges for investors in the global bond market, including against a backdrop of rising inflation and interest rates

  • Simon Prior, co-manager of the Premier Miton Corporate Bond Monthly Income Fund & Premier Miton Strategic Monthly Income Bond Fund
  • Lloyd Harris, Head of Fixed Income & co-manager of the Premier Miton Corporate Bond Monthly Income Fund & Premier Miton Strategic Monthly Income Bond Fund
  • Rob James, co-manager of Premier Miton Financials Capital Securities Fund

Learning outcomes:

  1. The impact on investor returns in a period of rising inflation
  2. The risks and opportunities in the financial and banking sector
  3. The outlook for inflation and interest rates in 2022
Channel: Masterclass
PRESENTER: Hello and welcome to this Asset TV master class in association with Premier Miton. Today we’re asking is the great bond bull market of the last 30 years finally over. And at a time when inflation is rising rapidly, what does that mean for those on fixed incomes. What can fund managers do to protect those. Well to discuss that I’m joined here in the studio by three members of the Premium Miton Fixed Income Team. They are Simon Prior. He’s co-manager of the group’s corporate bond monthly income and strategic monthly income bond funds. We’re also joined by Lloyd Harris. He’s co-manager of both those funds as well as being head of fixed income. And finally on the panel we have Robert James, co-manager of the Financials Capital Securities Fund.

Those are our panellists. Let’s start by finding out a little bit more about their day jobs. Simon Prior, let’s begin with you, tell us a little bit about what you focus on on the team?

SIMON PRIOR: Thanks Mark. So yeah I’m co-manager on the Strategic Monthly Income Bond Fund and the Corporate Bond Monthly Income Bond Fund. So looking across the credit profiles of companies from investment grade down to high yield and looking at relative value opportunities across that space.


LLOYD HARRIS: Much the same as Si. I’m looking at, you know, the corporate credit health of companies, whether it be investment grade or high yield or indeed financials. But also I tend to do a fair amount of macro-analysis as well, being head of the team, and looking at overall positioning and overall risk management of all the fixed income funds.

PRESENTER: And Rob, your background’s an equity manager, so what are you doing on the fixed income desk?

ROBERT JAMES: I’m the intruder. I make sure they’re doing their jobs! I have been an equity investor now for just over 30 years and for the vast majority of that I have been following the bank sector. And given that banks form such a large part of the fixed income world and they are the companies that issue contingent convertibles, which we buy in our financial fund, that’s why I’m on the team.

PRESENTER: Well, Lloyd, I mentioned in the introduction there’s, you know, inflation is taking off, that’s something we’ve not seen for a long time, so how are you and the team thinking perhaps a bit differently about fixed income from how you’ve had to do so over the last say 10 years?

LLOYD HARRIS: Exactly I mean before the pandemic we were unashamed deflationisters. And I think that’s changed a lot over the last couple of years. We were very keen to change the portfolios at the end of 2020 when bond yields were as low as they’ve ever been. And now, you know, we’ve run a short duration position ever since and that’s worked very well for us. We’ve also not run a great deal of credit risk during that time because we recognise that volatility in government bond markets will impact credit markets and they have done this year.

PRESENTER: Simon, from your perspective, how’s that changed your thinking on perhaps some of the places you look for research, some of the people you’re talking to, some of the historical data that you look at?

SIMON PRIOR: Right, I think to Lloyd’s point, I think this year has started off incredibly volatile and I don’t really see that going away. We’ve got increasing interest rates and we’ve also got central banks pulling liquidity out of the market. We’ve had QE essentially for the last five years really and they’re starting now to do QT, which is probably expected to take off in from the US central bank from May, they’re going to mention that, and also got the Bank of England talking about selling down their 20 billion of corporate run assets as well. So from that point of view it’s a real stock picker’s market but we have to be cognisant and looking for those names which are of stable or improving creditworthiness.

PRESENTER: And, Rob, in terms of that as a backdrop, what’s that like for financials in the rounds, we’ll come to CoCo specifically later.

ROBERT JAMES: Well I mean if you think back to 2007, from the global financial crisis onwards, banks have been under the cosh. They have been in a position where they’ve had to build their capital ratios from very low levels to very high levels. And to do that they’ve had to shrink their balance sheets and they’ve had to raise fresh equity at a time when interest rates have been held down by central banks. Now from a banking perspective that’s really tough, because you can’t make much of an interest margin if there’s no slope in the yield curve. So, from a bank’s perspective, today, an upward sloping yield curve with a little bit of volatility that Simon just mentioned is absolute joy. We haven’t been in a situation like this for a decade. So although inflation traditionally is not great for financial assets because they are nominal in nature, it’s very good for profitability for the banking system. So this is good news.

PRESENTER: And, Simon, we talked a little bit about some of the threats that are out there, but what are some of the opportunities that you see given this backdrop?

SIMON PRIOR: Well I think working the fixed income market, there’s just such a vast array of opportunity out there. You know, I always mentioned AT&T as a good example, as in whether you like the credit or not, it’s got one equity, it’s got like close to 200 different bonds out there, so whether, what type of duration you want, what particular currency you want, so you can take exposure exactly any way you want along that particular credit curve. So I think the opportunities in fixed income are just vast compared to any other particular market or large particular market.

PRESENTER: And, Lloyd, one, we’re obviously very focused on Europe at the moment with Russia’s war in Ukraine. We’ve talked about inflation. We’ve talked about the Fed. What are your thoughts on what’s happening in China, we’ve obviously got some real issues with the property market there, eyes aren’t, eyes in the west don’t seem to be focused on it at the moment, but do you worry there could be trouble brewing there?

LLOYD HARRIS: I think this is an important part of the mix, always, but particularly at the moment. China is undoubtedly slowing. It’s still got problems implementing a zero COVID policy. This means slower global growth. And this could come at a time when the west is having problems with energy prices. So the outlook is very unclear I think for global growth from here on in. If anything it’s been easy up until now. Now it tends to get more difficult as the inflationary [unclear 0:06:27] starts to hit wallets and hit corporate margins as well.

PRESENTER: And Simon given that backdrop, how much time are you spending thinking about the robustness of companies, balance sheets. I suppose in the past when rates have been low we’ve heard a lot about companies raising debt, extending the terms of their debt, does that still look a smart thing to do or what looked clever two or three years ago might now mean companies are looking rather overleveraged?

SIMON PRIOR: It’s an ever changing market, but I think the whole, the key thing as credit investors is to focus on downside protection. If you get it wrong, you get equity or nothing, with something which obviously our own investors don’t want. So we have to make sure across the whole team, with our credit analysts as well, is to focus on the downside protection and as I mentioned earlier like focusing on stable and improving companies, we’re very aware of those companies which are having margin compression as a result of input costs going up. And from the other side of that as growth slows, we’ve already talked about the cost of living crisis, it’s going to impact demand as well on the top line for some of these companies, so we need to make sure that we’re investing in those companies which are stable improving despite all of that going on.

PRESENTER: Rob, you mentioned there was a quite a benign backdrop for main profitability at the moment but what are the potential things that could go wrong if you’re sat on the sector, what are the potential problems that keep you awake at night?

ROBERT JAMES: Well inevitably we haven’t really had a credit cycle in Europe for a decade. Things have been put in place to stabilise economies and particularly since the pandemic struck, we’ve had all forms of furlough, just keeping bad debts as a non-issue for the sector. Inevitably bad debts will rise, as Simon was saying. There is a cost of living squeeze, the free flow of cash to families is reducing, and that will lead to a credit cycle. Now the important thing is that the banks have got enormous layers of capital built in to their capital structures. They price appropriately. So you have to remember when a bank makes a loan, it assumes that some of those loans won’t pay back. And as long as the capital is there behind it for unexpected losses as well, it should be fine.

PRESENTER: But Lloyd does raise the issue of defaults, what sort of level of defaults are you pricing in for corporates this year, is it higher than the long-term average, lower, what’s your feeling?

LLOYD HARRIS: Not necessarily for this year. We think this year in the main is going to be relatively benign. Corporate balance sheets are in good health. Bank balance sheets are in good health as well as Rob alludes to. However, we’ve got one eye on the fact that default rates will go up, almost certainly will go up, and that’s because input costs are going up for a lot of companies. There is less liquidity from central banks. That central bank liquidity has floated a lot of boats that won’t be there in the future. So it’s somewhat inevitable that default rates will go up. And for that reason, we’re not taking a great deal of credit risk in the funds. We’re not taking a great deal of risk in high yield for example. They are the most levered companies. They are the ones most likely to have problems. I think in general now, as Simon described, it’s a stock pickers’ market. I think maybe less so in financials, I think financials overall looks like the healthiest sector, but certainly in corporates it is very much a stock pickers’ market. You have to be in the right sectors and you have to be in the right companies.

PRESENTER: And Simon given that backdrop what Lloyd just said, does that mean if you looked at the corporate bond and the strategic bond funds, you would probably have a slightly higher weighting to financials in the rounds, Q1, Q2, 2022 than you would do normally and that the benchmark weighting is?

SIMON PRIOR: That’s probably true Nick. It’s probably worth saying so we’ve obviously got Lloyd and Rob both come from financials background, myself as well got an insurance background, so we’ve got the expertise across the team to be able to invest in financials and so we’re comfortable to do so. But we do have a slightly higher weight to financials across the fund and that’s held us in good stead so far.

PRESENTER: And Lloyd I mentioned in the introduction we got rising inflation, rising interest rates. I suppose it raises the question why should anybody want to invest in fixed income at the moment?

LLOYD HARRIS: So the market has gone a very long way to pricing a lot of interest rates, particularly at the short end of the curve, that’s the shorter-dated bonds. And they’re the bonds that typically carry a lot less price risk because they are so short dated because the duration is so small. Now the fact that that has actually happened gives rise to opportunity and gives rise particularly in the credit market in the shorter-dated bonds of financials for example. Some of the corporates we like are now paying 2, 3, 4, 5% for particularly short bonds. Those are bonds that are maybe one year in length, two years in length. And that there is a clear opportunity we think to take advantage of market pricing that has changed quite rapidly over the last six months or so.

PRESENTER: Well 6% sounds attractive over 12 months, but if inflation proves to be say 8%, doesn’t that mean you’re locking in a loss anyway, why would you do that as part of an overall portfolio?

LLOYD HARRIS: Whilst we expect inflation to maybe peak at 8%, we don’t expect it to average 8% over the next two years. So there’s a likelihood of [unclear 0:12:17] there in the bonds that we’re talking about, a positive real return. But also it’s a part of the market that is unlikely to exhibit a great deal of volatility. And I think that’s the important part as we go forward. Many markets have provided a very healthy return over the last few years, aided by central bank liquidity. That central bank liquidity is being pulled back. We expect continued volatility. Whether it be in certain parts of the credit market as we talked about in high yield, or also the equity market, and maybe getting a small positive real return over the next couple of years may look quite good.

PRESENTER: And Simon are you seeing evidence that, even if returns from fixed income aren’t great, even periods of stress it still provides if you like an insurance policy to an overall portfolio?

SIMON PRIOR: I think we’ve had significant volatility at the start of this year so I think anything that provides capital preservation, as Lloyd said, low volatility capital preservation, I think is actually going to look relatively attractive for many investors out there.

PRESENTER: Good. Lloyd, do you worry that if QT is kicking in and they’re taking all the quantitative easing away that will deflate not just equities but bonds at the same time?

LLOYD HARRIS: So typically QT is actually good for the bond market. So that removal of liquidity that’s typically gone into risky assets. So when you look at central bank balance sheets and the size of central bank balance sheets, it’s actually highly correlated to the level of equity prices. So in removing it, those equity prices that have been driven up by QE tend to start to maybe wobble. And the money then tends to go back into bonds and go back into safety as the liquidity’s withdrawn and as the market gets a lot more difficult. For example, 2018 was the last year in which we got QT from the US central bank and the best performing asset class that year was the German bund, and it was a year in which many risky assets actually fell in value.

PRESENTER: And, Simon, leading on from that, one thing the central banks have been doing over the last few years is buying quite a lot of corporate bonds. Do you worry that if and when they withdraw from that market, that’s going to have a negative impact on the price of high quality corporate bonds?

SIMON PRIOR: Yes hugely. We’ve already talked about the Bank of England are looking now to sell their £20 billion of purchases over the next few years, which is going to add to essentially another year’s supply to the sterling bond market. But the Central Bank of Europe has also been a huge buyer of corporate purchases over the last almost decade now, and now they’re looking probably to end their programme in Q3 this year, and it’s going to be a question of how that bond market’s going to react, but we’re certainly cognisant that that is happening and slightly wary that those names which have benefitted from it in the past may slightly underperform over the coming months.

LLOYD HARRIS: And it’s interesting I think on that point in that the market is not necessarily reacting in the way you’d expect it to, especially with respect to investment grade bonds, and the reason why is that there’s been a crowding out over the last years by the European central bank, as Simon said, and they’ve crowded out investors from the high quality bonds that they buy. Now the implication at this very point in time is that those bonds will not be bought by the Central Bank in future. However, what we are seeing in the market at the moment is investors going back into those bonds, investors were crowded out but they are now going back into those bonds for safety. So the highest quality part of the market and they are typically coming out of the more highly levered companies, such as the high yield companies we talked about, maybe lower reaches of investment grade as well, and going into very high quality bonds. It’s quite interesting. It’s almost the same as that effect of QT on government bonds eventually. We can see it happening in high quality investment grade corporate bonds at the moment.

SIMON PRIOR: Can I add to that as well. It’s also as well, interesting with the move in rates as well. It’s actually probably bought in the insurers back into fixed income as well. So they obviously look at asset liability matching so they’ve almost yield targets. And once they hit those yield targets, they’ll buy into those high quality assets, so it’s actually brought those buyers back into the market as well.

PRESENTER: And, Rob, one thing, I think we’ve heard a lot over the last few years, if you talk to bond fund managers they say we’ve got this great bonds out there because the banks are getting out of lending because of regulation, you talk to private equity, we’re raising lots of money because the banks are getting out of what they used to do. If that’s all true, how are banks going to make their money in the future when these crucial parts of their business are being taken away from them?

ROBERT JAMES: It is true that the corporate bond market is very much more developed in the US than it is in Europe, and it has been forever. And so the European market did need to develop and that has indeed been development. But if you look at the balance sheet of banks of Europe, they are very different from in the US, because in the US the banks don’t hold mortgages. They package them all up and sell them to Fannie and Freddie. Whereas in Europe the banks do have mortgages, so the vast majority of a bank balance sheet in Europe tends to be mortgage rather than corporate bond. The corporate bond, the corporate loan book tends to be quite a small part of the bank usually.

PRESENTER: We talked a little bit about inflation rising and interest rates rising, at the risk of getting you all to make predictions, I just want to get a bit of a sense, end of Q1, start of Q2 2022, what are you factoring in? Lloyd, what are your sort of thoughts on where inflation could get to, how far do you, what’s your sort of base case for where rates are going to go this year?

LLOYD HARRIS: So we expect a short-term peak actually in inflation in the US, very shortly, over the next couple of months, probably at the level that inflation’s at around 7 or 8% at the moment, and then in the UK we expect a peak in the autumn, very similar in Europe as well, possible double digit in the UK actually. So inflation could peak at quite a high level. And then we expect base effects to start to kick in and inflation to start to come down again. However, we don’t expect it to go back to target any time soon, we expect it to remain relatively sticky. In the context of the bond market, the bond market’s done an awful lot lately. It’s done an awful lot of heavy lifting and we think that for the time being we think yields have hit a short-term peak. We expect some consolidation over the next few months, but there’s a likelihood that they will go higher, government bond yields will go higher in future. However, we don’t think materially higher now this year, we think that’s maybe for the years to come.

PRESENTER: And just roughly to put a number on it, not to, but where are government, sort of 10-year government bond yields at the moment just to get some sense of where they are and where they’d need to get to for, you’ve said either we were a long way out on that or this is, you know.

LLOYD HARRIS: So the US tenure at the moment is at roughly 2½%. The UK tenure at the moment is roughly 1.6%. As I said we expect that to be a short-term peak. In the years to come after some consolidation, we may likely go higher into the 3-4% range for US treasuries; however, that is some way off, we think at the moment. For the time being it’s, this we feel is a short-term peak and it is an opportunity for bond buyers here in the near term.

PRESENTER: And, Simon, given that backdrop, what sort of yield do you need to see above government bond yields particularly corporate bonds then on high yields to compensate you for that extra credit risk?

SIMON PRIOR: Well maybe more than we were seeing last year anyway. It’s interesting we talked about the Central Bank’s now pulling out of the corporate bond market, so there’s obviously just less buyers in, and obviously with the volatility that we’ve seen in the corporate bond market as well, you need to be paid for that as well. So when new issues are coming to market, you know, in normal days sometimes you get 10, 20, 30 new issues across the sort of the developed market space, they need to come cheap. Everyone recognises that interest rates are going up and we’ve had loads of company treasurers just wanting to come to market to get their bond issuance away at whatever level they can, obviously as cheap as they can for them, but they’re happy to just seed a little bit, so investors can get involved and we’re happy to take the other side of that at the moment.

PRESENTER: Well, Simon, you mentioned that volatility. So is that changing in any way the way that you think about how you buy bonds in the market? Are you having to adopt slightly different techniques to get into and out of bonds in this period of volatility?

SIMON PRIOR: Well I think always as a team we’ve got one quality bias and this plays to our strength. The other traits I think that we have is we’re generally extremely disciplined across everything that we buy. We’ve already talked about downside protection, we’re looking for those stable and improving credits. We’re looking for those bonds that trade cheap relative to their peers. So from that point of view, nothing has changed. Obviously we’re just reinforcing every single point we’re making about the disciplined nature of our investments.

PRESENTER: And, Rob, can you give us a bit more detail, you’ve talked there, we’ve talked about the opportunities and financials and so forth, but can you put a bit more detail on that? So what sort of offers do you get if you’re an investor looking at CoCos at the moment, what’s the risk, what’s the reward?

ROBERT JAMES: Yes CoCo is a form of bank capital. It’s there to protect depositors in the event that the bank loses a lot of money. So when banks issue CoCo, they are topping up on top of their equity. So the first line of defence, as a CoCo holder, is there’s a whole load of equity sitting underneath you on the balance sheet that gets eaten first. Now, back in 2007, that level may have been about 5½%, today it’s over 15, and it’s measured today in a way that is very much more rigorous than it was in the past. Then you look at the liquidity of the banking system. Just in the UK alone, banks have got hundreds of billions of pounds worth of liquidity that back in 2007 they wouldn’t have had at all. So then we look at how do you differentiate between the banks. You can look at the profitability. Profitability ultimately is the very first line of defence against losing money in a cohort.

So we like banks that are profitable. Then you look at how long they’ve issued the CoCo for. CoCos are perpetual in nature, they go on forever. They are permanent parts of the bank capital but they have calls. And when the first CoCos were issued back in 2013, everything had a five-year call. As time went by and investors became more and more familiar with the asset class, that extended, and in the last few years we’ve been getting CoCos that have got an issue, a called call date ten years in the future. Now that’s adding to duration as Lloyd was talking about and they were coming at a time when spreads were really tight and rates were really low. So some of the very long dated CoCos, actually ended up with very low coupons and we found that as a cohort deeply unattractive.

So we didn’t play in that part of the market at all and in the last couple of years we’ve moved shorter and shorter and shorter. We’re not as short as we could possibly go, but you can as a stock picker find, as Lloyd was talking about, you can find some really attractive issues that have got a year or two to run with a yielding 5 or 6%. And because conditions are a little bit uncertain at the moment, there are some big names, big nation champion banks coming back to the market with new five-year issues in the 6 to 7% region. So once again we’re finding some really good value in some good quality names.

PRESENTER: So just you mentioned there a call date, five years out, 10 years out. What does that mean, you hold your convertible and at five years do you have to turn it into equity or do you get a choice and if you don’t it just carries on being…

ROBERT JAMES: No, the only point at which they convert into equity is if something goes really badly wrong. What happens at the call date is the bank is allowed, as long as the regulator says it’s OK, the bank can call the bond back and give you your money back. But in order really for it to do that, it has to have enough CoCo in issue to make sure that its capital ratios don’t fall below the requirements. So what a bank will do generally is issue a new CoCo and from the bank’s perspective that hopefully will cost a little bit less than the old one did, and then they’ll call the old one and lower their overall cost of capital.

PRESENTER: You mentioned there about the amount of capital the banks have built up on their balance sheets, but recently I think we’ve seen NatWest that says oh actually we’ve looked ourselves, we’re overcapitalised, we’re going to give some of this money back to shareholders, I think, as a special dividend. As a holder of convertibles, is that a sign of the health of the sector or does that give you the heebie-jeebies, they’re starting to get too confident, they’re chucking money around?

ROBERT JAMES: Well one of the things that happened at the beginning of 2020 as a response to the pandemic was regulators asked banks in their entirety to stop paying dividends. Now, if you stop paying dividends, the profits that you make as a bank just accumulate on your balance sheet as capital. And then subsequently we all expect a big credit cycle to come as people were laid off and lost their jobs but furlough stepped in and so there were no bad debts either. So the banks were accumulating capital and not losing it in bad debts and consumers were being entirely rational and paying off their high cost debt. So if you looked at the credit card balances in the UK as an example, they fell by about a third over the period from the beginning of 2020 to today.

Now that has left the banks very highly capitalised. So, if you’re a bank, what do you do with your excess capital? You can either lend against it and that tends, if you start lending deliberately aggressively that normally ends badly. You make bad decisions on credit. You can acquire things. You can go into an M&A binge and that tends not to create value either. Or the third thing you can do is you can give it back to your shareholders and let them do something with it. And as long as the capital that is left within the bank is adequate or more than adequate, that’s probably the best thing for the banks to do.

PRESENTER: Interesting. Final question on this one, obviously the banks are much better capitalised than they were in the global financial crisis, but that’s a relative game, there would still be those out there who said back in 2008, it was insane the level of leverage in banks, now it’s merely frightening. Is there any truth in that or is it genuinely changed…?

ROBERT JAMES: That’s a very fair challenge, but you have to take the view that the banking system is a risk-taking business. Now you could conceivably have every single loan backed by hundred percent capital, and then there would be no risk whatsoever in the system and depositors would be absolutely fine. The problem with that as a system is that nobody would be able to afford to take out a loan because the rate would be so high to remunerate the capital that you’ve had to have in the bank. So there is a balance between having enough capital to protect your depositors and make the system stable and having too much capital that people can’t afford to borrow. And that’s the game that the regulators have to play. And you’re absolutely right, if you go back to 2007, there wasn’t any capital in the system at all, and the only capital that was available to absorb losses was the shareholders’ funds. And all the other bonds, the tier 2 bonds, the senior bonds, everything, they were all sacrosanct, they never lost money.

Today in our banking system we’ve got multiples of the amount of equity, but all of the other bonds all the way up to non-preferred senior are bail-in-able. So in the event that something bad happens, we don’t need to go back to the government to be bailed out, we can actually in, all of those capital holders will incur losses in the resolution of the bank.

PRESENTER: Thank you. Lloyd, just one other quick question on the financial system, one thing we’ve seen with what’s going on with Russia and Ukraine is sanctions, everybody’s chasing oligarch money around. Do you have any worries there might be a bit of an existential threat to the banking and financial system as governments and regulators start to chase money, actually this is a sector that could get itself a very bad reputation?

LLOYD HARRIS: As we’ve seen with Credit Suisse recently, I think reputational risk is a big deal for banks. It’s a big deal for any company but particularly I think the banking sector. So I think bank management will be at pains to ensure that they are doing the right thing here. That they are not contravening sanctions at all. If we think back to Iranian sanctions and the fines that were handed out then by the US in particular to the likes of BNP and Standard Chartered, you know, it’s a shot across the barrel really in terms of showing banks that they really need to comply with these Russian sanctions and that’s the reason we’re seeing banks pulling out of Russia. So I think the initial impact of the sanctions has started to wash through the markets. We’ve seen that over the last month or so. There will undoubtedly be other headlines I think from a markets’ perspective and impacts from a market’s perspective, but I think for the banks themselves, you’ve got to think that now they should be, for now in fairly good shape with regards to Russian sanctions.

PRESENTER: And Simon just coming back to inflation, we mentioned a little earlier the cost of living crisis, but at the moment we’re beginning to see prices going up in the shops. We obviously, energy bills are going up from the start of April, but they probably haven’t really hit yet. What happens if we wind the clock forward three months, four months, it’s going to feel a lot more painful I would guess. At that stage, how do you think about what that could do in terms of what governments, regulators are starting to do around prices, how consumers are feeling. How do you feed that in to the potential outlook for some of the companies that you’re investing in at the moment? Presumably there might be some sectors that are more vulnerable than others.

SIMON PRIOR: Yes very true. And it’s an interesting time obviously. We’ve come out of the pandemic as Rob talked about as an amount of bad debts would just fell through the floor and savings rates actually went up for the general populous. So there’s a probably a lot of savings for consumers to get through initially before they feel the real pain, certainly in the middle classes, and there’s obviously a lot of pent-up demand as well as hardly anyone’s had a holiday for the last couple of years. So I imagine those sectors who are still in the opening up trade shall we call it, I imagine they’ll still do relatively well. But you’re right in three months’ time it’s probably only likely to get worse and you expect to see growth rates probably slightly fall off from what we’ve seen over the last couple of years, which is on top of, as we talked about earlier, you’ve got those companies which have got the margin compression from a result of input prices going up and you’ve also got the demand side going down as consumers have less money to spend. So from that point of view, you could get a really big impact on companies’ earnings.

PRESENTER: And we’ve got about five minutes left on the show, so I want to move on to another topic which is the whole issue around ESG. One of the things we’ve got with all the inflation at the moment is a real big conversation at the moment about what’s the right kind of energy mix to have, balancing national security with things like net zero. What sort of impact’s that had on your thinking around what constitutes ESG and ESG-able investments?

SIMON PRIOR: Well obviously it’s a hot topic across everything at the moment but particularly that the fixed income markets I think ESG plays a huge part in actually the returns that you get and the demand for certain securities. For us we do actually have an ESG screen across all of our credit funds. And so the way we’re looking at it as we’re still thinking that we want to be financing the future technologies. We don’t want to really be adding to the sort of the carbon output that’s out there already. So, for us, whilst obviously those oil companies are making significant hay while the sun is shining, we’re still keen to look at the other technologies and the green technologies and help support that change because we obviously need to rapidly move ourselves away from Russian gas and oil as quickly as we can.

LLOYD HARRIS: And I think it’s actually quite interesting the way the credit market in particular is reacting to this. We’re not necessarily seeing the strength in some of the oil names for example, some of the oil majors that we’re seeing in equity. The green bid within the credit market is very strong and the lack of green bid for dirty companies, some of these oil majors for example is also very weak. I think January was a good example this year. During January, we had very strong equity performance on the back of rising oil prices, but because we had a relatively weak credit market, the worst performing sector during that time was actually oil and gas within the credit market. And it kind of makes sense in terms of what’s going on at a geopolitical level as well.

Because you look at the response to COP26, it was very interesting we thought in terms of certain difficult decisions couldn’t be made by politicians, and they’ve ultimately deferred those decisions to the financial sector, and part of that is making it very difficult or more difficult for oil companies in particular to be able to finance or more expensive for them to finance and we are actually seeing that in the credit market. So it’s not a, one it’s something we don’t want to do, but two it’s not a sensible place to put your money either in the long run.

PRESENTER: Do you worry Lloyd that over time that’s actually quite a worrying place to be as a fund manager because now, government essentially is outsourcing to you the tough decisions it doesn’t want to make and you’re going to have to make those with your investor’s money and that’s, you know, once you get into a world of values rather than getting the best value for your client, there could be misalignments of capital. How do you avoid that?

LLOYD HARRIS: Well, the two very much go hand-in-hand though and I think that’s, I think that’s, the point of what I’m saying and the point of what Simon’s saying is that the market is really looking at these companies and thinking well do we really want to loan to them for 10 years, do we really want to loan to these companies for 30 years, because ultimately we don’t know what these companies are going to look like in 10 or 30 years’ time. There’s such a push I think to actually save the planet and develop green technology that these companies don’t necessarily have that technology at the moment. So I think what’s actually good for the planet is actually good for credit-holders as well. And being out of these bonds is to our mind the right trade, much like being out of tobacco bonds, 20 years ago, those bonds have just widened, they’ve underperformed, we’ll see the same in oil and gas, we’re pretty sure.

SIMON PRIOR: We’ve always said you may be able to buy these bonds relatively cheaply but we’re a very active team and for us to make money we need to be able to sell them at a higher price or a tighter spread and there’s just less and less people willing to buy those particular securities. So you may be able to buy them cheap, because you’re not necessarily going to be able to make a total return…

PRESENTER: You could sell the profit as well.

SIMON PRIOR: Yes exactly.

PRESENTER: OK. We are almost out of time. Want to get a final thought from each of you. We’ve talked about so much over the course of the last 40-45 minutes and there’s a lot more we could talk about. But out of everything we’ve talked about today, if there’s one key element from that you want to leave us with, what would that be? Simon, let’s start with you.

SIMON PRIOR: I would probably say 2022’s started off incredibly volatile and I don’t necessarily see that potentially going away in the credit markets. So I think having a high quality bias I think is actually key for investors to have, you don’t want to be whipped around in these markets, particularly if people are buying what they think is quality bond funds and they’ve just been moved around like similar to equity performance. So I think having that high quality bias I think is important for investors to have in these uncertain times.


ROBERT JAMES: I would say that there is out there an entire generation of fund managers for whom banks are not of investable quality, and they have a long memory of when things go bad it normally gets worse for the banks, even worse for the banks, and my take on that would be have a look at the balance sheets then because things really have changed in bank land. Banks are now much less volatile, much more secure than they were in the past and as a result of that, as active managers, I think we have the opportunity to pick up some really attractive bonds when other managers sell them.

PRESENTER: Lloyd, a final thought?

LLOYD HARRIS: Almost a bit of what Simon and Rob have just said. The volatility in the market and actually the presence of inflation, we think is going to lead to shorter business cycles. So that implies you need to be a very good stock picker and you need active management and we think the days are gone of very benign, long business cycles. This presence of inflation makes things very difficult for central banks and that means market volatility and you’re going to want I think an active manager to take advantage of that.

PRESENTER: We have to leave it there. Thank you for watching. Do stay with us, we’ve got some information coming up in just a second on how you can potentially use this as part of your structured learning. It just remains for me to thank today’s fantastic panellists, Simon Prior, Lloyd Harris and Robert James from all of us here, goodbye for now.
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