A cuppa and a catch-up with…. Torcail Stewart and Lesley Dunn

Sam Slator 05/07/18 in Strategy

The managers of Baillie Gifford Strategic Bond fund believe that trying to second-guess central bankers is a bit of a fool’s errand and instead stick to what they do best: picking individual bonds. While this may seem simplistic, the in-depth research they carry out to find ideas is anything but.

Co-managers Torcail Stewart and Lesley Dunn visited our offices last week, and here’s what they had to say.

How do you go about picking a bond?

“Corporate bonds offer two sources of potential outperformance relative to the index: yield return and capital appreciation. We look to identify bonds where the yield will fall and price will appreciate ahead of the broader market. Within each of these categories, we identify two sub-sets. For the yield category, these are ‘steady’ and ‘compounding’, while in the price appreciation category, they are ‘accelerated’ and ‘event driven’.

“If one of us doesn’t like a bond it won’t go in the portfolio – we have to agree in order to have true conviction.

“When we have team meetings, it’s the junior analysts who talk first, so we know we are making time for fresh views and they are not being drowned out by more experienced peers.

“If we like a bond we will size it relative to the opportunity we think it gives. This generally means a decent sized holding, and the only positions that represent less than 0.75% of the portfolio are those we are building up over time or those which are on their way out of the fund.

“We then monitor how it is performing. We don’t do this on a quarterly basis as that’s too short term. Instead we set our own milestones and undertake health checks along the way. Milestones could be management turnaround, a ratings upgrade, or an asset purchase – it all depends on the individual bond.”

Can you give a couple of examples of some holdings?

“We hold the University of Cambridge in our portfolio. It is a high-quality issuer with net cash on its balance sheet and deep pockets, thanks to wealthy and generous alumni. It shouldn’t be impacted if the UK economy hits problems as people travel from around the world to study there. It is basically issuing bonds in order to raise money and build world-class facilities, to stay competitive relative to the other big universities.

“We also hold Netflix. Netflix isn’t trying to be the next Amazon, or to offer too many differentiated services at once. It just focuses on what it does best – streaming films and TV shows – and therefore isn’t competing with any of the other US tech giants. It’s clearly the leader in its field, given that new TVs all now come with a ‘Netflix’ button.”

Why is now a good time to buy bonds?

“Some people say that bonds are a bit of a hard sell at the moment because we’ve had a 35-year bull run. But I think a lot of investors become too fixated on interest rates and inflation – for a couple of reasons.

“Firstly, the US and UK central banks will have to tread very carefully when it comes to inflation and rate rises, as moving either of these too quickly at the moment could easily cause a recession. We therefore don’t think that interest rates are going to suddenly rocket and cause the value of your fixed income portfolio to plummet.

“Secondly, it’s possible to identify businesses that can perform in any environment. There will also always be parts of the fixed income market which are faring better than others.

“We’ve been underweight emerging market bonds since the start of the year, for instance, which in hindsight was a good move as the asset class has been one of the losers so far in 2018. But we made the move for longer-term reasons: China is potentially slowing and valuations simply aren’t as compelling as they were. We are finding more ideas in North America.

“Meanwhile, we added to high yield bonds in the first quarter of the year, after the market wobbled on the back of Italian political uncertainty. Around 34% of the fund is allocated to high yield bonds now.”

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