Ian Francis, manager of the 7.1%-yielding CQS New City High Yield (NCYF) investment company, is alive to the risks presented by elevated stock and bond markets.
While stock markets trade at record highs, the high yield bond market is also enjoying lofty valuations, after a strong two-year rally.
Francis tries to look for bonds in 'niche areas' in order to avoid paying too much for yield, but acknoledges that the wider high yield market is looking expensive.
And while he isn't predicting an imminent crash, he does see echoes of 1987, which produced Black Monday, in the behaviour of the stock market.
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Daniel Grote: Hello, I’m here today with Ian Francis, who is manager of the CQS New City High Yield fund. Ian, thanks for joining us.
Ian Francis: Thank you Daniel, it’s a pleasure to be here again.
DG: I mean looking at the performance of the high yield market globally, really over the last two years because that’s where it has really rallied, are you worried?
I’m thinking about the UK’s most famous investor Neil Woodford, a couple of weeks spoke about his fears of a stock market bubble, and he was pointing to things like the European high yield market where there are yields that are less than US treasuries.
IF: I would agree that the stock market valuations and high yield valuations in the general market are high. We try to go to niche areas that the larger investors can’t necessarily go for. For example the OneSavings Bank holding that we have is a £70 million issue. If you are a large investor, you’d need the whole issue. We don’t, we only need a small percentage of it.
And, yes, I’d agree with him that it could go quite nasty. But we haven’t got too much inflation here yet. That’s going to be the thing that would, in my opinion, set things off. If we suddenly went to 4% and held it, I think that would worry a few people.
DG: Another thing that you share with him is you’re exposure to Provident Financial. He’s a famous investor in the stock, you’ve just bought the bonds.
IF: I held them prior and sold them at 114 about 18 months ago and when they found the banana skin we had another look at it and thought, well, the bonds at around the 95 level are fair value and the risk-reward is looking correct for us, so we put a small holding into Provident Financial again.
DG: I guess it’s a different set of calculations for a fixed income investor. I mean the bonds didn’t fall anything like as much as the 70% the shares fell. And when you are backing a company in the sort of situation that Provident Financial finds itself in, I guess you don’t need to see a full blown recovery in the company, do you? You just need it to keep going.
IF: You need it to survive and recover a certain percentage. Because they will be able to refinance those bonds at the moment, I think, without too much problem. Obviously all the pain has been in the equity because I think, one thing I do notice in the equity market at the moment, it is punishing people very hard for missing profit targets or whatever, and last time I remember that was 1987, but that doesn’t mean a crash coming.
DG: You mention in your last set of results that really it’s Brexit and Trump that are the areas that could derail, well, all areas of markets. What are the threats to high yield in particular.
IF: let’s take the Brexit. We end up with a hard Brexit, you end up with an even weaker Tory government, sterling has a hard time, investors pull out of the UK, you know, you’re not necessarily going to be in a very nice place anywhere in the market. If you have a really bear market, like we’ve seen, say in ’87, the great crash of 2008/9, there are no places to hide. You just have to make sure that your portfolio is in companies that will survive to live another day.
DG: I mean presumably with the area of the market that you’re looking at, even when we’re not in times of heightened stress, this issue of companies keeping going and not going bust, that’s always going to present an issue if you’re looking for the sort of yields that you’re looking for.
IF: Yes, it’s always front and centre of your mind when you’re looking at a company and you know, once it’s in the portfolio you keep an even closer eye on it. Fortunately, we didn’t have anything in Steinhoff.
DG: This is the South African company that’s in big trouble…
IF: It looks like at least fraud, but could be a lot worse than that.
DG: I mean fraud’s one case, but just more generic downturns in company fortunes, given that you’re looking for a high yield, you will be investing in some distressed companies.
IF: What I try to do is get into stocks that, if it’s going to be a long term holding because, you think it’s going to survive, just, or if it doesn’t, you can get out of it, or it’s not going to hit the portfolio. You’ve got to have a diverse portfolio. You’ve got to have a very diverse portfolio. We have 100 major holdings in the portfolio. If I was to go for a lower yield type fund, you could probably get away with 40 holdings.
DG: I mean looking at the future for the fund, since you’ve run it, the dividend has gone up every year, I guess that will be your main challenge.
IF: that will be a challenge. Because obviously in the past we’ve been able to grow the dividend because we’ve had the currency call right. Obviously not only does it give you a capital gain but it gives you an income gain. Obviously yields are not – 2008/9 we were buying 10,11% yields, which was fantastic. You’re now buying 7% to 8% yields, so the opportunity for growing the dividend gets less. We are allowed to have 20% in equities, so if inflation starts taking off so you have dividend growth from some equities that could be a way where we could increase the dividend, one hopes. But at the end of the day, you just keep on doing the day job, working hard, trying to find the companies that have got a yield that is more than it should be. It’s never easy, but that’s what I love doing.
DG: Well Ian, thanks a lot for your time.
IF: Pleasure Daniel, thanks a lot for seeing me again.