Pockets of value in the bond market

Having experienced a significant bounce back from the falls in March, corporate bonds are not as attractive as they were six months ago: yields have fallen as prices have risen. But there are opportunities, according to Jonathan Golan, manager of Schroder Sterling Corporate Bond fund.

While the easy gains have been made, Jonathan believes there are pockets of value in companies impacted by COVID-19, but which will recover and come back strongly. And he’s investing in those he thinks are industry champions.

Investing in unloved companies

“Ryanair is an example,” Jonathan said. “Airlines have been hit particularly hard by the pandemic, but Ryanair has a virtually unencumbered fleet of planes and net debt below $1 billion. I invested at height of crisis in a 1 year bond with a 20% yield. Southwest Airlines in the US is another example. It has the best balance sheet of all US airlines and entered the crisis in a strong position: more cash than debt and an unencumbered fleet of planes. It is also focusing on the domestic market, which I think will recover more quickly.

“In the hotel space I like Premier Inn. It’s well positioned in terms of the macroeconomic cycle as it is lower to middle budget and it owns most of its hotels, so it’s really low risk lending.

“I’ve even found opportunities in exhibitions. This sector has obviously seen a huge dip in activity due to social distancing, but Informa, the global events business, has a lot more to offer. Its key source of revenue is a company that is an academic publishing business – and it just generates cash. Overall, its debt level is lower than pre-crisis.

“But to find these opportunities, we have to undertake a lot of labour-intensive credit research to make sure companies are robust and ensure they have the liquidity to survive. We ask ourselves: if these companies had no revenues for more than 12 months, would they be OK? We also look for a margin of safety in the yield or other business revenue streams and some asset backing – like the firms I’ve mentioned that own their own planes and hotels.”

Richard Woolnough, manager of M&G Optimal Income fund, is also finding opportunities in unloved sectors. “Prices on many investment grade bonds have risen to 2020 highs and valuations are not as compelling as before the crisis,” he said. “We have sold some banks and telecoms recently, with the latter facing competitive and structural issues that make holding their paper less attractive from a risk-reward basis. AT&T, Comcast and Deutsche Telekom were some of the bonds we sold in August.

“Instead, we continue to favour bonds issued by carmakers and oil/gas companies, where valuations remain cheaper.” Bonds from General Motors and Volkswagen are among the fund’s top ten*.

Emerging market bond opportunities

Both Ariel Bezalel, manager of Jupiter Strategic Bond fund, and Jim Leaviss, manager of M&G Global Macro Bond, have found selective opportunities in emerging market bonds.

Jim Leaviss comment: “One area in which I do see value is emerging market debt. Firstly, it offers higher real yields than developed market bonds. Also, emerging market currencies have lagged the recovery, meaning that some local currency bonds do offer attractive value (you can buy more for each dollar spent).” The fund currently has exposure to Mexican, Indonesian and Russian debt*.

Ariel added, “The outlook for the rest of this year looks very uncertain as, even outside of the questions about the spread of the Coronavirus, the market is going to have to deal with the potential volatility around the US Presidential election and also the on-going and tortuous negotiations around the Brexit process.

“Over the course of the month (September) we have added to exposure in Australian government bonds. We have also maintained exposure to 5 year Russian and 10 year Chinese Government debt, even though we are generally cautious on the outlook for emerging markets given the severity of the economic outlook, the reduction in international travel and tourism, and also the overall damage to global trade. However, in our view, Russia and China have the economic levers to be able to lower their real yields to support the economy into the recovery.”

*Source: Fund factsheet, 31 August 2020