Short-duration bonds aren’t purely a defensive play. Mike Count, manager of the LF Canlife Short Duration Corporate Bond Fund, sees selective opportunities for attractive returns among recovery and growth names.
Rising yields have prompted investors to shift towards shorter-dated bonds. But heading for the short end needn’t be akin to donning a hair shirt, hunkering down and awaiting better times in the medium- and longer-duration areas of the bond market.
Although short-duration corporate bonds have rallied with hopes for an accelerating global recovery, some COVID-impacted names are still trading significantly wide compared to the market, which is back at pre-COVID levels.
There may be further tightening of credit spreads in the sectors that were most affected by the pandemic – principally the retail, property, travel and leisure industries – as investors anticipate a recovery in these areas during 2021.
With low-beta, single-A spreads now tight, the LF Canlife Short Duration Corporate Bond Fund is using a barbell strategy for new purchases. We hold AAA agency and covered bonds to maintain liquidity, while higher yielding insurance names and consumer-facing companies offer scope to generate good returns as spreads recover.
Pubs and airports offer some interesting upside potential given the success of the UK immunisation programme and the rebound in economic activity, but there is also steady growth and stability to be had from the unglamorous world of closed book life insurance.
The nation’s pubs have opened their doors (again) and are enjoying a surge in business that is benefiting one of our top recovery picks – Marston’s.
After seeing the strong rebound in pubs’ trading performance during last summer’s lockdown easing, we analysed the sector for names that could cash in as lockdowns end. While many individual pubs and smaller chains struggled to survive, it became clear that Marston’s, one of the UK’s largest pub operators, was in a resilient position. In particular, the partial sale of its brewing business had provided substantial liquidity that would enable it to withstand a prolonged period of full closure.
We purchased an amortising floating-rate Marston’s issue that offered security over properties, a yield of 5.7% and was trading below par.
The group had been downgraded to sub-investment grade status, causing some forced selling that depressed the price to well below par despite the issue being secured on Marston’s properties. Our own credit assessment of the issue is BBB-, higher than agency ratings of BB+, suggesting further upside to come. We’ll raise a glass to that.
Poised for take-off
Gatwick may not be the most charismatic airport in the world but there is a lot to like about it at the moment. While Heathrow dominates the UK’s business air-travel market, Gatwick is geared to towards short-haul and low-cost tourist flights, which are likely to bounce back more quickly than business travel as international COVID restrictions are lifted.
Gatwick’s management rose to the challenge of the pandemic with a comprehensive plan to cut costs and preserve cash. By the end of 2020 Gatwick’s liquid reserves were of £573m, enough to meet operating cashflows, planned investment levels and interest payments for 2021.
We purchased a four-year BBB+ rated Gatwick Airport bond at the end of 2020 when it was still trading at a significantly higher spread than pre-pandemic levels and provided a yield of 1.54%.
The recent surprise removal of Portugal from the UK’s Green List of destinations is a reminder that returning to normal may be a bumpy ride, but pent-up demand for foreign holidays is not going anywhere.
A different kind of insurance
In addition to recovery plays, we have also been seeking out names that provide a likeable combination of stability and growth prospects. One such is insurer Phoenix Group, which has £338bn of assets under administration. Following its acquisition of Standard Life Assurance in 2018 and ReAssure in July 2020, Phoenix is the UK’s largest long-term savings and retirement business. We purchased Phoenix’s BBB rated 2025 bond in January 2020 at a yield of 3.2%.
What we like about Phoenix is the low sensitivity to investment market risk provided by its business model. The company is a leading player in the UK’s closed book life insurance market in the UK (insurance policies that are closed to new business but are still premium-paying policies). This is a market with a strong structural growth story, and one which Canada Life itself participates in and knows well.
The long and the short of it
We remain positive on the outlook for short-dated corporate bonds. Short-dated yields are unlikely to move far from zero, but further steepening is likely, albeit not at the same pace as in the first two months of 2021. We expect any near-term increases in inflation and associated yield rises to be transitory effects of disrupted global supply chains and labour markets.
In the meantime, we can expect the short duration corporate bond market to be relatively well supported. Although the Bank of England is no longer buying corporate bonds as part of its asset purchase programme, sterling-denominated corporate bonds continue to receive a boost from the EU’s monthly purchases of euro-denominated corporate bonds.
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