Should bond investors worry about defaults?
The number of voices predicting a recession are growing. The UK economy contracted in the first...
On 12 January 1908, scientist Lee de Forest made the first long-distance radio message broadcast from the Eiffel Tower in Paris. It was heard by an audience of 50.
110 years on, while radio transmissions have stood the test of time, we now also have television, email, mobile phones and social media: the way we communicate today is vastly different. I doubt de Forest ever imagined US policy would one day be communicated via twitter, or that we could just as easily converse with someone on the other side of the world via Facetime as we can our next door neighbour.
As the sector has developed, so have the investment opportunities. However, when I researched funds investing in this industry, I was surprised to see that it was more popular with bond fund managers than equity managers.
For example, Liontrust Monthly Income Bond has 17.6%* invested in telecommunications bonds. The team managing the fund believe that, after several years of intense competition and merger and acquisition activity, the telecoms sector appears to be stabilising, with many companies enjoying improving operating trends.
They say that this is in part due to our increasing dependence on broadband and mobile networks, which has led to telecoms becoming a quasi-utility sector, providing what have become essential services. When you combine this with the fact that they are regulated by government backed entities, they believe it is a relatively lower risk sector offering good value opportunities, following a period of underperformance.
The Liontrust team favour the larger European incumbents, such as Orange and Deutsche Telekom, with their focus on improving the balance sheet, together with reduced event risk, as regulatory constraints limit potential M&A consolidation, driving improved performance and a return to growth.
Torcail Stewart, manager of Baillie Gifford Corporate Bond fund, also likes the sector and has 10.4%* invested in these companies’ bonds. Positions include AT&T, Bell Canada, Digicel (a Caribbean based company), Swiss company Matterhorn, Millicom (which services Latin America and Africa), Orange and Vodafone.
Torcail commented: “We have traditionally liked telecoms because they are highly cash generative and typically operate in oligopolistic markets. Regulators are usually happy with this oligopolistic industry structure, in part because such business lines are also capital intensive and They invest in infrastructure; we want our mobile phone networks to advance, progress from 2G to 3, 4, 5G and handle more data at faster speeds, thus stable regulation has broader benefits to society.
“From a bond-holder perspective, a cash generative business with moderate leverage in an oligopolistic market is an attractive area to lend. Of course, for each of the companies to which we lend there will be nuances to the investment case. For example, AT&T bonds are cheap versus their peers and, in the long-run, I think the merger with the sizeable content provider Time Warner makes sense. If Trump throws a spanner in the works on the deal the bonds are still callable at a price higher than we paid.
“A more recent third reason is that if Trump delays the deal beyond 22 April 2018, the bonds have to be called. This is not a great situation for AT&T, so they will likely have to approach bond-holders for an extension. If they do so, they’ll have to pay up to bond holders and we may be in a strong position to receive a higher fee.”
The Baillie Gifford High Yield Bond fund also has a high weighting to the sector: 12.4%*. It is also invested in Caribbean Telecom provider Digicel. This business does carry quite a lot of debt. However, with its capital intensive fibre roll-out plans largely complete, the managers believe cash generation will improve. With bonds yielding circa 6.7% to a 2021 maturity, they believe this to be an attractive yield for a company that could easily sell off one of its island business units should it ever choose to reduce debt more rapidly.
Other Elite Rated bond funds with significant weightings to telecoms include M&G Strategic Corporate Bond (14.9%*), M&G Corporate Bond (12.8%*), Invesco Perpetual Corporate Bond (12.1%*) and M&G Optimal Income (11.4%*).
*Source: FE Analytics, as at 9 January 2018.