Despite Brexit looming, BlackRock’s Citywire + rated Ben Edwards believes the UK corporate bond market provides ‘relative stability’ compared to its developed country peers and ample alpha generation opportunities.
Although Edwards, who manages BlackRock’s Corporate Bond fund, says the outlook for the next two years as the UK begins negotiations with the European Union (EU) is ‘softer’ at best, it is benign for the asset class.
‘With Brexit, in the next two years we think that business investment will not be too strong, and businesses’ input costs will also rise due to the fall in sterling. There’s also less than stellar data coming out of the housing market,’ he said.
‘There’s a number of factors that are not armageddon or doomsday scenarios, but it does seem like there is a softer outlook at best, which actually works well for bonds, if inflation doesn’t shoot up.’
And relative to the US and Europe, Edwards said the stability offered by the UK makes the market attractive from a bondholder’s point of view.
Preference for the UK
Last month, the UK received the biggest upgrade compared to the other major economies in its forecast for economic growth from the International Monetary Fund (IMF). The organisation raised its forecast for 2017 to 2% from 1.5% in January.
Edwards said: ‘From a bondholder’s point of view, we have a preference for the UK. We feel like there’s going to be relative stability here.
‘When you have stability in the gilt market, you have stability in the corporate bond market. That’s why we have a preference for sterling-denominated corporate bonds.’
Edwards said he is cutting his exposure to Europe and the US because of the relative lack of stability. On the US, he said: ‘We feel the Treasury market will be far more volatile – the Fed’s hiking rates, the policy with Trump is far more uncertain.
‘And on corporate bond markets, the fundamentals have started to weaken. Corporates are not earning enough to pay dividends and fund share buybacks. The only way they can afford that is to take on more debt.’
Moving away from financials
In the corporate bond market, Edwards has a preference for telecoms and utilities companies, and is moving away from financial assets.
He said: ‘We’re adding to names like BT and Verizon, which issues in sterling, and utilities like Thames Water, which is providing really good value at this point.
‘We’ve moved away from volatile financial assets and more towards underperforming UK corporates. We look for access to assets or visibility on cash flow, both of which are visible in telecoms and utilities.’
Edwards is also vocal when it comes to the ability of fixed income managers to outperform, and said that global bond markets – particularly corporate bond markets – are ‘fantastically inefficient’ and therefore provide alpha opportunities.
He argues that fixed income markets are less efficient than equity markets, citing research pointing out that a bigger proportion of active fixed income managers can outperform.
According to active bond house Pimco, bonds are different to equities in the active versus passive debate. It calculates that 63% of active bond funds have outperformed their median passive peers over the past five years, in research published last month.
In comparison, Pimco said, only 43% of active equity mutual funds and ETFs outperformed their median passive peers over the past five years and that, within equity, most active funds and ETFs in each of three largest categories – large growth, large blend and large value – underperformed.
For Edwards, having fund flexibility is ‘absolutely key’ to generating alpha: ‘We need to be able to invest in multiple currencies, across multiple markets with both physical bonds and derivative products to extract as many of the pricing anomalies as possible.
‘A simple example is buying bonds from British Telecom in the US dollar market where participants may not understand the company as well as a UK manager and it is therefore cheaper,’ he said.
‘A more complex [example] would be taking derivative exposure to financial issuers where we think there is a similar income but, for technical reasons, a much lower chance of experiencing a loss than if we owned the actual bond.’
BlackRock’s Corporate Bond fund has delivered a total return of 23.1% over the three years to the end of March, compared to the sector average of 21.4%.