Although you would expect a fund manager to be positive on the area he invests in, Ben Edwards, co-manager of BlackRock Sterling Strategic Bond (GB00BZ6DDM04), makes no bones about the fact that bonds will not be a great source of income in the near future. But he also maintains that they have an important distinction that makes them an arguably more attractive source of income than equities in the near future.
“They’ll be extremely poor [as a source of income],” he says. “But if we think about what else can you buy to generate income the answer is not a lot. The last three months [has seen] a never ending list of companies cutting their dividends and that’s the difference between bonds – even with low yields – and dividends. One of them [bond coupons] is contractual.”
He adds that with central banks driving interest rates down close to zero and even considering negative rates, an income that is “anything more than zero and will stay at a fixed level becomes incredibly important to investors".
In any case, BlackRock Sterling Strategic Bond’s focus is on total returns rather than income, as reflected by its yield of around 1.9 per cent, which is lower than that of many other Sterling Strategic Bond sector funds.
“The likely driver of returns over the next 12 months won’t be the yield," explains Mr Edwards. "It’s likely that the price either going up or down is going to be a larger proportion of the overall return. [So] we’re far more focused on which assets we think can survive the environment we’re going through, and whose spreads can tighten and prices can increase.”
To get these gains Mr Edwards and his colleagues are looking widely – only 40 per cent of the fund’s holdings at the end of April were issued by UK companies and around 25 per cent of its holdings were issued in euros.
“Two years ago we would have had almost no euro-denominated assets but we’ve been building into that position,” says Mr Edwards. “Our positions and expectations of forward returns are a combination of the diversification and the companies we can access, the underlying risk-free yields, the spreads on offer, and the hedging costs. When looking at European credit we see some pretty attractive spreads and we’re hedging out the interest rate risk, so not taking the very negative yields that are largely on offer on the continent. And the European Central Bank’s (ECB) [bond buying] programme looks like a far more powerful tool to drive credit spreads tighter than, for instance, the Bank of England’s or Federal Reserve’s programmes. The ECB holds a large amount of outstanding European investment grade non-financial assets and we think that by the end of the year it’ll hold a much larger proportion. But [this fund’s] 25 per cent in European currency bonds may be through global, US or even UK companies that issue in the European market.”
Around a third of the fund’s assets – its second-largest geographic exposure – are issued by US companies.
“The sorts of companies that we like in the US market are some of the banks,” says Mr Edwards. "Negative rates can have an impact on bank earnings and that’s affecting European banks.”
The fund’s third-largest holding at the end of April was a bond issued by US bank Wells Fargo (US:WFC), which matures in 2025.
He also likes US companies – and ones in other regions – that they think should be far more resilient in a recession. These include “cable operators, telecom companies, and even some of the tobacco companies where we think revenues and earnings are going to be far better protected – irrespective of the scope and the length of the recession,” says Mr Edwards. “So we really have some defensive plays at the moment.”
At the end of April, these included bonds issued by Time Warner Cable and Philip Morris International (US:PM), and in the UK British American Tobacco (BATS), Imperial Brands (IMB) and BT (BT.A).
The fund’s cautious stance is also reflected in its allocation to investment grade rated bond issues, which rating agencies consider less likely to default. At the end of April, it had around 86 per cent of its assets in debt rated BBB or higher.
“[Although we can] buy more in high yield, over the last few years we’ve increasingly believed that this growth cycle was getting a little long in the tooth,” explains Mr Edwards. “We [saw many] late-cycle indicators in the economy, particularly in credit markets, so our desire to be exposed to high yield rather than investment grade [debt] has been pretty low over this entire period. It felt like a recession couldn’t be too far away. We had no special knowledge that coronavirus would give us an opportunity to buy investment grade assets very cheaply or high yield would struggle, certainly in the first quarter [of this year]. But we can see when valuations are uncompelling and the economic cycle is starting to turn, meaning that we’re much better off in [investment grade debt]. We’re going to really see which of these companies are going to survive and in what shape they’re going to be as we move through the lockdown and towards the end of the year.”
That said, he thinks that their assessment of a company's strength is more important than what rating its debt has.
“We could have something like half a trillion dollars worth of global investment grade assets downgraded to junk (high yield),” says Mr Edwards. “[But] just because they’re downgraded from triple B to double B doesn’t mean that they are going to default – only a very small portion of those [are likely to] default after being downgraded. So the question becomes are you being appropriately compensated for the risk of a downgrade at the moment? There will be some things at the levels we are currently seeing that I would be happy to buy, even if they are downgraded from triple B to double B. It’s far more important to me that these businesses will survive to pay us back. As long as the business is sound, the cash flows are stable and we think it will survive, the difference between being a triple B and a double B maybe somewhat theoretical.”
Ben Edwards CV
Ben Edwards has been lead manager of BlackRock Corporate Bond Fund (GB00B4T5JV79) since 2012 and co-manager of BlackRock Sterling Strategic Bond Fund since its launch in 2016. He has been at BlackRock since 2010.
He worked at Legal & General Investment Management between 2003 and 2009, most recently as a portfolio manager responsible for sterling corporate bond portfolios. Mr Edwards began his career as an analyst at M&G Investments in 2002.
Mr Edwards earned a business degree from Queensland University of Technology in 2000 and a post-graduate degree in finance from the Financial Services Institute of Australia in 2002. He is a CFA charter holder.
