Lower for longer is the new mantra as the anchoring of low-end rates continues to drive yield-thirsty investors to distraction – certainly in the UK and Europe though perhaps a little less so in the US.
Whispers about a bond bubble have been around for several years, but with asset buying by central banks becoming an established policy measure, utterances are becoming louder – and not just from investors. There has been a raft of high-profile investment executives warning of bond overheating.
Large flows have obliged many bond fund managers to seek ways to fully invest them. Increasingly, bigger funds contain more securities or larger positions in individual lines, with managers sometimes forced to move up the credit spectrum to maintain a decent yield in a world of tight compression. Have these flows caused a material increase in credit risk for bond funds?
It is worth examining two popular bond sectors to see in which credit buckets UK bond fund managers are concentrated.
Looking at the IA Sterling High Yield Bond sector, as of September 30 the highest average allocation was in BB-rated credit (39 per cent), followed by B-rated (34 per cent). Twelve months ago these allocations were 39 and 37 per cent respectively. Five years ago the average sector exposure to BB-rated securities was 34 per cent, with 36 per cent to B-rated securities.
This year average exposure to A- or better-rated securities was 11 per cent, but for 2015 this figure was 9 per cent and for 2011, 15 per cent. The balance between investment and non-investment grade overall has moved up for 2016; a total of 19 per cent in investment grade, up from 14 per cent for 2015 and down from 22 per cent for 2011. The most significant change over the past year has actually been the drop in aggregate exposure to riskier, unrated securities: down from 10 per cent to 5 per cent, appearing to have funded the commensurate rise in investment-grade securities.
In the ‘go anywhere’ IA Sterling Strategic Bond sector, the highest aggregate concentration as at September 30 is in BBB-rated securities at 26 per cent, followed by BB-rated at 15 per cent. The pattern was similar last year, with 24 and 15 per cent respectively.
For 2011 funds in this sector contained an average 21 per cent in BBB-rated securities, with the highest allocation being to AAA ratings at 23 per cent. The overall aggregate exposure to investment-grade credit for 2016 was 59 per cent. For 2015 this figure was 56 per cent, and for 2011, 67 per cent. Aggregate exposure to unrated securities in this group was 9 per cent for 2016, down from 10 per cent last year and 8 per cent in 2011.
Over the past 12 months, and compared with five years ago, it appears bond fund managers have not materially decreased the quality of their portfolio holdings. Fund managers appear to be backing their ability to cherry-pick in safer credits and not chasing higher credit for the sake of it – even if the credit cycle has been extended. This should provide investors some comfort in the case of a rapid rotation out of corporate bonds.
