Why strategic bonds are an attractive option for investors

Sam Slator 17/05/2023 in Fixed income

In this video we delve into the reasons why strategic bonds have emerged as an attractive option for investors seeking to diversify their portfolios, effectively manage risk, and achieve a reliable stream of income. Our guest, Torcail Stewart, co-manager of the Baillie Gifford Strategic Bond fund, shares valuable insights on how this fund capitalises on its stock-picking expertise to unlock the potential of strategic bond investments, while maintaining a prudent approach to credit quality allocation.

Throughout the discussion, Torcail Stewart sheds light on the three key characteristics of the companies held in this concentrated portfolio, discussing their resilience and long-term prospects. Despite recent headlines, Torcail explains why the fund remains highly invested in the banking sector, highlighting the underlying quality and rationale behind this decision.

Finally, to showcase the diversity within the fund, Torcail presents two notable holdings: Yara International, a global fertiliser company, and InPost, the Polish delivery service, demonstrating the fund’s ability to identify and capitalise on compelling investment opportunities.

I’m Sam Slator from FundCalibre. And today I’ve been joined by Torcail Stewart, co-manager of the Baillie Gifford Strategic Bond fund. Thank you for joining us today.

[00:10] Good morning, Sam.

This is very much a stock picking fund, but you’ve talked recently about looking for resilient businesses in particular, because the macro environment is so unpredictable at the moment. Could you perhaps tell us more about these companies and their characteristics?

[00:26] Sure, sure. So, thanks Sam. The three central tenets that define resilience for us are firstly strong long-term prospects – a company effectively producing the products and services of the future, not the past. Secondly, sustainability: is the company compatible with a sustainable economy? And thirdly, a resilient capital structure: debt leverage effectively that it can handle.

And good examples of companies meeting such criteria are NTT, that’s Nippon Telegraph and Telecom Corporation. Now NTT is a leading telecommunications provider in Japan. It has a dominant position in Japanese fixed line and fibre to the home sectors. And it recently consolidated its markets presence through the acquisition of leading mobile provider, DOCOMO. Now, this did cause leverage to rise, but the company’s strong cash generation and commitment to deleveraging will see the balance sheet glide back to strength over the coming years, is thus very well placed to weather the present market turbulence, and the dollar bonds of this defensive single A corporate are offered on a yield of 5% when hedged to sterling.

Another example of resilient businesses in our portfolio is the likes of Pension Insurance Corporation. This is the UK’s leading bulk annuity provider. The company is a huge beneficiary of higher rates because as trustees, you know, have had a wild time and other asset classes they seek to de-risk, unless there’s a wall of demand coming PIC’s direction. Indeed, the strength of demand in bulk annuities we think, should also lead to a strong bid for Sterling Corp Credit as we move into next year. PIC bonds are offering a yield of 7% just now.

And finally, further afield, we have MercadoLibre [, Inc.], a leading Latin American e-commerce platform and payments business that links merchants with buyers online. And we believe this company will enable the transition to a sustainable economy. It is democratising commerce, driving competitive markets and contributing to improving socioeconomic development in Latin America. And it’s these characteristics that really strengthen the growth story for this lowly-levered business. Now, MercadoLibre bonds, they’re yielding an appealing 6% when hedged back to sterling. So, we really have a resilient range of corporate bonds with supportive long-term prospects that are well placed to weather really a range of macroeconomic scenarios.

And you’ve got quite a lot in the banking sector. Are you not worried about what’s been going on in the US and Europe?

[03:08] So, regulation of banks post the global financial crisis we think has been extensive. However, in 2018, Trump signed legislation that reduced regulation of smaller banks in the US and it is small, US regional banks which are facing the challenges today. Now, an equivalent rollback of regulation did not occur in Europe. European banks, if you follow the recent Q1 results have, in the main, beaten consensus estimates; that’s in revenues, provisions and capital ratios. We’ve seen really reassuring results. And the banking institutions that we lend to in Europe are generally those resilient banks deemed too big to fail, such as NatWest or Barclays or Santander. And our largest positions are in the senior bonds of these banks, so, near the top of the capital structure. They’re such short-dated senior bonds we see offered on a yield of 5.8% for three-year paper.

Across the pond in the US, we lend to JP Morgan and that’s a huge beneficiary of the regional bank debacle. We also have some AT1 bonds, most of which are short-dated and high coupon in nature from solid financial institutions. Our largest position is that of LeasePlan [International]. Now, LeasePlan has the leading position in the European car leasing market and a long and strong financial track record, including a propensity run with a conservative capital structure. The business will soon have the added backstop of one of France’s leading national champions, Société Générale. That bank is soon to complete its acquisition of LeasePlan, which rating agencies tell us will be quite a positive development. So, our 7% coupon LeasePlan AT1 bond is yielding 10% to call in May next year. And in the rare event that it were not called, the bond would transition to a coupon of 10%. So, this is really expensive debt for LeasePlan and thus we believe the likelihood of a call is very high. So, we are finding European banks in good shape and appealing yields can be found at the top and selectively, the lower parts of the capital structure. So, there are opportunities in the banking sector we believe for the bond selector, at this point in time.

And perhaps a great example of how this fund can invest in any sector, in any stock, is you’ve got Yara International [ASA} I noticed, which is a global fertiliser company. I mean that sounds very defensive and dull, perhaps you can tell us a bit more about it. Is there more [to it] than meets the eye?

[05:45] Yes. So, defensive it is, yes, but dull we might disagree a little bit there. So Norwegian Yara International is the world’s largest nitrogen fertiliser producer and two fifths of its shares are owned by the Norwegian government. Now fertiliser one immediately thinks stable demand, and that’s true in the short run, but times are changing and many countries are actually seeking to reduce their usage of fertilisers because their production is very carbon intensive, and overuse by farmers can lead to nitrous oxide emissions. So indeed, after [the] oil and gas sector, Yara is actually the largest emitter in Norway. So, not great credentials. So, what really won us over to this? Well, Yara is also at the forefront of reducing those emissions. It has the ambition to be carbon neutral by 2050 and has already halved its carbon emissions in the last 15 years. Plus, this company is also proactive in encouraging fertiliser use by farmers. So, it’s been offering real-time nitrogen sensors as part of a digital tool suite to improve yields and lower emissions.

Now we believe it is important to support those progressive emitting companies that are really reducing their emissions, because their positive actions will ultimately really move the dial. So, Yara is also cognisant that they must shift their business model away from traditional fertilisers, and on this front they’re innovatively leading the field in areas such as supplying green ammonia for the shipping industry. So, as a novel fuel source which could materially reduce emissions from the world’s highly polluting shipping fleets. So, we see Yara as a company that’s moving in the right direction. Bonds from this conservatively levered treble B rated business are offered on a highly appealing 6.5% yield. That’s when hedge back to sterling. So, really quite good yields on offer in in the treble B space these days.

And you’ve reduced your high yield weighting quite significantly, I think you’ve got a very select group of companies in that space now. Could you talk to us about one of your names maybe InPost [S.A.]?

[07:52] Sure. So yeah, that’s right, we have refined our high yield exposure. That’s really given the prospect of a slowing macroeconomic environment as those rate hikes really start to bite. So, one of our top picks is InPost as you rightly posited; it’s 2% of funds. InPost is a parcel delivery company in Poland. So, just think of the number of times you miss a parcel delivery and end up having to visit your local post office to collect them. And that really has a time and carbon cost. So, InPost provides a solution to this problem via its automated parcel machines, the locker network. Now these lockers really enable parcels to be delivered and collected without fuss, that one notes – that really greatly reduces the excess of journeys you have to make on both sides. So, in Poland, believe it or not, half the population is now within a five-minute walk of an InPost locker. And InPost distribution capability is such that even Amazon uses their network in Poland. So, clearly, this is a really promising growth company’s brilliant Polish concept, [and] is now being rolled out across a range of European countries, even including the UK. And with a solid balance sheet and appealing business model, this is a company which we think is likely to scale with time and will see a positive rating trajectory as a consequence of that. So, its bond yields 7% when hedged back to sterling so it’s a very appealing yield.

And really, this is just one of the many compelling corporate bond investment cases available in our Baillie Gifford Strategic Bond fund today, a fund that’s presently yielding 6% and that’s net of fees.

That’s great. Thank you. Yeah, I’ve used InPost myself, I used it for a Vinted delivery that I had for that. So yeah, I know it was very convenient, just around the corner from my house. So yeah.

Thank you very much for that Torcail, that was very interesting. And if you’d like to find out more about the Baillie Gifford Strategic Bond fund, please go to FundCalibre.com.

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions.Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice.Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.