Top-performing fixed income star Mike Riddell believes there is more ‘juice’ in the corporate bond market, expecting it to continue its rally from mid-March into next year at least.
The Citywire AA-rated manager’s £1.7bn Allianz Strategic Bond fund is two-thirds invested in corporate bonds, around double the weighting of its Bloomberg Barclays Global Aggregate index benchmark. This was the latest in a series of recent strong directional calls that have propelled the fund to stratospheric outperformance of its peers.
Riddell’s fund is the best performing fund in the Investment Association’s Sterling Strategic Bond sector by a substantial margin both in 2020 and over longer time periods.
Since the turn of the year, the fund is up 22.6% while most rivals in the sector have lost money, with the average fund down 1.3%. His fund is top over both three and five years, up 39.4% and 46.2% respectively, versus averages of 7% and 15.7% from the sector.
Riddell entered 2020 upbeat on the strength of the global economy. This led him to be bearish on government bonds, but also corporates on valuation grounds as spreads tightened to lows not seen since June 2007, ahead of the financial crisis.
But his positioning changed both swiftly and markedly from mid-January into early February as Riddell moved the fund heavily into sovereign debt, while shorting corporate bonds as the coronavirus began to take hold.
‘We realised very quickly it was going to cause huge problems for the global economy and that’s when we went as bearish on credit as we could because corporate bonds were pricing in almost no default risk,’ he said.
‘Through February/March we went from being very worried about the global economy until we saw huge stimulus, more than in 2009, and valuations quickly flipped the other way.
‘Corporate bonds went from being the most expensive in 12 years within a month to the cheapest in 10 years.’
Profits from sell-off and rebound
Switching the fund’s credit exposure from a 20% short position to two-thirds long of corporates meant it was able to profit from both the sell-off and subsequent rally.
Riddell (pictured) put a lot of the money coming into the fund – it had inflows of £400m in March alone – into new issuance from battered blue-chips raising capital as the pandemic cut off their revenue streams.
He said this strategy continues, albeit with the yield premiums seen at the peak of the panic having come down from the abnormal highs seen in March.
‘What we’re seeing now is that the new issuance premium, where all these new issues were very attractive to the same company’s existing bonds in the market, isn’t there to anywhere near the same extent. It’s actually disappeared completely for anything which is in a non-cyclical sector which is rated A or higher,’ he said.
‘The tweaks we’ve made to the general strategy over the last month and where we’re seeing more value in corporate bonds, is actually to look a bit lower down the credit risk spectrum.’
The fund has no high yield exposure, with Riddell saying new issuance from selected BBB or BBB-rated names, such as BMW, offers a much more attractive risk-reward profile, as he is able to pick up yields nearly 200 basis points over US Treasury bonds.
‘The market is clearly very panicked about any corporate bonds rated just above junk bond status and we are finding a lot of value there in the ones we’re pretty confident won’t get downgraded and you’re getting a really big yield pick-up.’
He believes this play has further to run and although corporate bond spreads – the difference between their yield and that of government bonds – have tightened since mid-March, he notes volatility remains elevated, presenting opportunities.
‘I suspect corporate bonds have done around two-thirds of their rally. I think there is more to come, so it still makes sense being overweight credit risk, but the juice isn’t there to the extent that it was a month ago, clearly,’ he said.
‘There might come a point when if everything is expensive and nothing is moving, and interest rates are zero everywhere in the world, then it becomes harder to generate alpha, absolutely. But we think that’s going to be a good year or so away at the minimum.’