Top tips for SMSF investors: Corporate bonds
An interview with fixed income expert David Carruthers, Head of Credit and Core, AMP Capital
What are some of the key themes in the fixed income sector at present?
Investors remain progressively more cautious in the near term, with low bond yields, concerns surrounding Greece and the uncertainty around the timing of US Federal Reserve rate hike. This is offsetting positive sentiment regarding policy support in Europe and the stabilisation of the oil price.
A major theme over recent times has been an ebbing of the forces that pushed yields down so aggressively in Q4 2014. Commodities and the dollar have stabilised which has served to normalise short-term inflation expectations – this has seen yields unwind some of the Q4 2014 rally. From here we feel any sustained rise in yields will require stronger global real activity data.
A lack of liquidity in a rising rate environment is another theme front of mind. A competitive advantage of the AMP Capital Fixed Income team is our active use of derivatives. These instruments allow the Corporate Bond Fund (CBF) to hold onto names we like amidst volatile markets by utilising credit default swaps to hedge credit beta without having to give back stock to the market.
We are also active in utilising tools to improve liquidity and marketability. In fact, electronic trading platforms such as ‘MarketAxess’ are revolutionising the bond market, offsetting pressures from regulatory driven liquidity conditions. MarketAxess provides new transparency and channel access to ‘fund-to-fund’ liquidity. Our scale is also a competitive advantage for accessing internal liquidity (and avoiding bid / ask spreads).
What are the main drivers for corporate bond returns?
Prevailing interest rates; the financial health of corporates and investors’ overall perception of risk in global market.
What risks should SMSF investors consider?
Benchmarks have become riskier during recent years as borrowers have extended their maturity profiles. This has led to increased duration in fixed income benchmarks. Accordingly, rising interest rates can pose a significant threat to .investors. In order to prudently reduce the CBF’s exposure to interest rate sensitivity the duration has been reduced over the last week from 1.33yrs to circa 1yr. This positioning was reinforced by our view that the domestic rate cutting cycle is largely completed in terms of easing. We increased the fund’s flexibility in 2014 by delinking the duration limit from being benchmark relative (i.e. index +/- 1.5 years) to now be managed within an absolute framework (i.e. 0 to 4.5 years).
Investor sentiment is being affected by the ongoing uncertainty regarding the future outcome of Greece’s bailout funding negotiations. We recently bought credit protection via a CDS index (i.e. iTraxx Main (Europe)) against a part of our credit portfolio to temporarily reduce our credit exposure amidst the Greece uncertainty. Due to the number of safeguards in place from the ECB and national regulators we don’t see Greek contagion risk as being as severe as in previous periods. Accordingly, we will lift hedges on any volatility overshoot and look to add credit as we still like the underlying global policy support and corporate fundamentals. Importantly, our credit analysts retain high conviction views on specific industries and individual issues.
Any advice for SMSF investors considering investing in corporate bonds?
Corporate bonds are traditionally considered lower down the risk spectrum than shares. Nevertheless, when exploring income investing from corporate bond issuance it is prudent to have a focus on investment-grade credit. While the search for yield leaves many SMSF investors with choices surrounding how much risk to carry, it is important to invest in companies with strong or improving corporate fundamentals, a solid management team with a bondholder focus, whereby a normalisation of global growth could translate into revenue and earnings growth.
For more information, see the AMP Capital Corporate Bond Fund page.
About the author
David Carruthers leads the Global Fixed Income team’s credit and core bond fund capabilities and is responsible for macro credit strategy. Mr Carruthers was previously Senior Portfolio Manager within Credit Markets from 2003 and led the Credit Portfolio Management stream as well as macro credit strategy.