Valentine’s day investment picks

Sam Slator 13/02/2023 in Fixed income

Valentine’s Day is a day when lovers and admirers around the world express their affection with romantic dinners and thoughtful gifts. For some it is anticipated with excitement, for others with a feeling of dread.

To celebrate the saint’s day, we asked four fund managers which investments are catching their eye and which they are avoiding.

Government bonds vs corporate bonds

Mike Riddell, manager of the Allianz Strategic Bond fund, says that he is the most bullish of government bonds that he has ever been. “Central banks are still behind the curve, but we think they’ve now gone too far the other way,” he said. “They’re still hiking (and indicating more hikes to come) when we think they shouldn’t be. We expect inflation to return to target by early 2024, and we expect a nasty recession later this year. If we’re right, there’s a good chance of an enormous government bond rally.”

Corporate bonds on the other hand, and risky assets generally, look completely mispriced according to Mike. “Yes, yields are historically high, but that’s because central bank interest rates are high, not because you’re getting rewarded lots to lend to riskier companies,” he said. “It takes about a year for any changes in interest rates to have an impact on the economy, so we still haven’t felt the impact of all the rate hikes of the last year. Normally, the extra yield on corporate bonds over government bonds – the ‘credit spread’ – gets bigger as recession risks grow, but we’re not seeing that yet. Not only are we underweight corporate bonds versus our benchmark, we are outright short where mandates allow.”

SPACs vs Small Caps

Rupert Rucker, investment director for the Schroder US Mid Cap fund says that the team dislikes very speculative companies that don’t own anything . “These are companies that have no profits and yet make up over 10% of the universe,” he said. “They are classically dominated by biotech companies, but there is also a new area called SPACs.”

A SPAC is a publicly traded corporation with a two-year life span formed with the sole purpose of effecting a merger, or ‘combination,’ with a privately held business to enable it to go public. They raise money largely from public-equity investors and have the potential to derisk and shorten the IPO process for their target companies, often offering them better terms than a traditional IPO would.

“These are really speculative investments,” said Rupert,” and the outcome is usually very binary – only a very small percentage make it.”

The team loves US small caps. “US small caps are really not very small,” said Rupert. “In fact, they are much bigger than some European large caps! If a UK smaller company wants to become large, it needs to go outside the UK, creating huge risks – in our universe these companies can get to a big size just by operating in the US. And there is no liquidity risk.”

Asian banks vs utilities

Rizi Mohanty, a fund manager on the FSSA Global Emerging Markets Focus team, says that Indian private banks are an area the team favours – in fact, they make up almost half of the team’s India exposure. “Valuations have been below long-term averages and we’ve been adding selectively to holdings,” he said. “The Indian banking system credit penetration is still only around 60% so there is room to grow,” he told us. “What’s more, private banks continue to gain market share from their state-owned competitors. We prefer plain vanilla banks – predictable, conservatively run banks with a strong deposit business.  The formalisation of the economy is also a tailwind.” Both HDFC Bank and ICICI Bank are in the fund’s top ten holdings*.

In contrast, Rizi says that the team tends to avoid utilities companies, having been burnt in the past. “These companies are heavily regulated, so the upside is capped while the downside isn’t,” he said. “Often, when investors start making good returns on equity, the government or regulator steps in and says it’s a social service, so profits are limited. We did once invest in Manilla Water, which operated in the greater-Manilla area. We felt it had room to expand across the Philippines and could replicate its good track record. When the company wanted to increase its tariffs though the government said no.” The team also has a hard exclusion policy on tobacco, ammunition, and gambling companies.

European industrials vs residential property

The IMF has forecast that the eurozone will grow 0.7% in 2023. That’s not huge growth – but it’s better than the UK! “Encouragingly, the companies we have spoken to recently – particularly those in the industrials space – are reporting a growth slowdown but not a significant deterioration for their business,” said David Walton, manager of the IFSL Marlborough European Special Situations fund.

“For example, where sales may have grown in the high double digits last year – 48% in the case of one of our companies – they expect the growth to be lower, but still good. In this environment we prefer firms that have resilient businesses, such as a French healthcare company we hold that operates care homes and post-surgery rehab clinics. This type of service is required no matter what is happening in the wider economy.”

In contrast, David says that the more concerning downgrades are concentrated in areas such as residential property development and other consumer-facing sectors like DIY that did well during lockdown. “Residential property development is a tough market,” David said. He mentioned the Swedish housing market as an example. “It enjoyed very low interest rates for mortgages for a number of years and these rates have now risen rapidly.”

As a result, house prices in the country are falling at one of the fastest rates in the world. The triple whammy of mounting costs of living, higher borrowing costs and falling home values is creating economic pain, with Sweden now at risk of falling into the worst recession in the EU**. “As a result of all these pressures, we’re not invested in any housebuilders in the Nordic region,” said David. “We hold one small business in France, but that is it.”

*As of 31 December 2022
**Source: M&G, 18 January 2023

 

Photo by Kelly Sikkema on Unsplash

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