More defensive and selective

12 August 2014 - Following a strong run for corporate bond markets, we are more defensive and selective, says Ariel Bezalel.

Ariel Bezalel, manager of the Jupiter Strategic Bond fund

Corporate bond markets have enjoyed the tailwind of European Central Bank policy easing and generally cautious rhetoric from the US Federal Reserve in the past three months. While this has benefited the asset class, we believe it is important not to become complacent, and continue to place emphasis on seeking capital preservation, while still aiming for a high income and the potential for capital growth.

Concerns about high yield valuations

Following the recent rally, there is growing nervousness about valuations in the high yield bond market. Although we believe that underlying fundamentals remain intact (growth momentum remains steady and very few companies are failing to pay back their debts), we generally share this nervousness. The last quarter of the year was unprecedented in terms of the number of deals that we have walked away from. Not only have we seen a shifting in the balance of power from lender to borrower, but, in our view, a number of deals are being priced to perfection and are not offering investors enough reward for risk.

A cautious approach

We have always approached the high yield bond market with caution. At the time of writing about 24% of our exposure to high yield was in systemically important banking names, while 64% of our exposure excluding banks, was senior secured (we would be front of the queue to get our money back if the company defaults). We also focus on relatively defensive industries and economies. Europe is currently in more of a sweet spot than the US, where leverage is ticking up and the balance of power shift has been most notable. In addition, we have reduced portfolio sensitivity to a possible increase in interest rates.

Taking time to reinvest

At this point in the cycle, we are willing to bide our time and allow cash from maturing bonds to build up. We are trying to use this effectively (such as in Greek government bonds at yields of around 3%) while we wait for better opportunities to invest. However, being cautious does not mean we are less active. We continue to explore areas not necessarily captured by more index-oriented investors and seek out mispriced deleveraging stories like the Co-operative Group, where we believe fundamentals are changing for the better.

Divergent risks

Usually, heightened risk causes a drop in volatility, but concerns over the end of quantitative easing and geopolitical risk seem to have led to a rather eerie calm in markets in recent weeks.

In an environment of divergent risks, including heightened geopolitical tensions, a key challenge is to build robust defences, while allowing our investments to flourish. We have taken a number of positions aimed at reducing risk in the portfolio. These include using 5-year US government bond derivatives (if the value of the bond falls, the fund makes some money), holding positions in Australian government bonds and having a meaningful position in the US dollar of around 8%, which has typically benefited from safe haven flows (when investors get scared they tend to turn to this asset class as it offers a degree of safety compared with other assets). It is a benefit of our flexible approach that we can take strategic positions like this in times of uncertainty.