Batten the hatches! Investment firm executives in the loan and bond industry are beefing up their defenses against the market storm

Investment companies in the AIC Debt – Loans & Bonds sector face a challenging environment of rising inflation and interest rates, combined with the prospect of increased credit risk as economic growth slows.

The sector offers an attractive average return of 7.04%. However, total returns were negative over one and three years, with losses of seven% and 1% respectively. In five years, the sector has returned 3% and over ten years its average total return is 44%1.

Investment firm managers use a range of tools to deal with volatile market conditions, including shortening of duration in their portfolios (by investing in bonds that are less sensitive to interest rate changes) and by increasing exposure to variable rate debt. Some take advantage of their closed structure to deploy gear and invest in less liquid debt Where ready.

To explain these strategies and give their outlook for fixed income, Association of Investment Companies (AIC) gathered feedback from executives of investment companies in the Debt – Loans and Bonds sector.

Why invest in loans and bonds now?

Rhys Davies, manager of Invesco Bond Income Plussaid: “Inflation and higher interest rate expectations are negatively affecting the broader bond market, but we believe that at the current level of credit spreads and total return, an actively managed allocation to high yield bonds offers an attractive income and total return opportunity.

“While inflation data remains elevated, markets have effectively priced in a series of hikes from major central banks. In the case of the Federal Reserve and Bank of England, we are now in a situation where new Interest rate hikes are only catching up with market expectations Inflation data will continue to be the focus of market concern and similarly, should there be any downside surprises, markets would probably react positively.

Adam English, Director of M&G Credit Income, said: “Floating rate bonds and loans could be a good investment in the current inflationary environment. Indeed, the income from these instruments is linked to benchmarks that move in line with central bank interest rates, which the market expects to rise over the next twelve months. These loans and bonds may also offer a complexity or illiquidity premium, meaning they may provide higher income than traditional government and corporate bonds with equivalent credit ratings. This helps to further offset the effects of inflation on returns.

Pieter Staelens, portfolio manager of CVC Income & Growth, said: “With high inflation, central banks around the world raise interest rates to bring inflation down. Loans have a repayment rate that moves in tandem with central bank interest rates, unlike bonds which have a fixed rate at issue. In times of rising interest rates, we believe investors are generally better off investing in loans rather than fixed rate bonds, as their payment rate will likely increase with the base rates set by central banks Bonds, on the other hand, generally lose value as interest rates rise, as their fixed rate of payment becomes less attractive.

What are you doing to protect your portfolio against inflation?

Simon Matthews, Senior Portfolio Manager of NB Global Monthly Income (NBMI), said: “The much lower duration profile of floating rate loans allows the fund to manage interest rate risk effectively. Floating rate senior loans with a term of approximately 0.25, act as a low cost hedge against inflation and as interest rates rise, coupons float higher. About two-thirds of NBMI is allocated to floating rate loans.

Rhys Davies, manager of Invesco Bond Income Plussaid: “We believe that an important part of our role in protecting our investors against inflation is to invest in a portfolio that can generate a high level of income. The current market offers an increasing number of bonds which we believe can put Invesco Bond Income Plus in a position to pay a good level of dividend. The current dividend of 11p represents a dividend yield of 7%. This dividend is entirely covered by the current income generated by the portfolio.

Why invest in loans/bonds using the closed-end investment company structure?

Ian Francis, Director of CQS New City High Yield, said: “The benefit of being in a closed structure in times of high volatility is that you don’t have to sell the most liquid parts of the portfolio to fund redemptions, so you can keep the portfolio structure as you wish rather as dictated by the need to sell what you can.

Adam English, Director of M&G Credit Income, said: “A closed-end investment company structure allows us to invest in private and less liquid loans and hold them to maturity. Open-end funds, on the other hand, may sometimes be forced to sell assets to manage client outflows. Investors in private companies can still retain access to their capital by buying and selling the publicly traded shares of the company.

Simon Matthews, Senior Portfolio Manager of Global Monthly Income NB, said: “One of the main advantages of investing in high yield corporate loans and bonds within a closed-end investment company is not having to manage cash outflows and being able to invest in alternative credits, which also offers the possibility of obtaining a return with a lower risk of market volatility.

Rhys Davies, manager of Invesco Bond Income Plussaid: “The ability we have to borrow is an advantage. We can use repo funding for several purposes. We may add exposure to general credit risk, if we believe the level of return is an attractive reward for risk. Alternatively, we can generate higher income from higher quality bonds, instead of taking exposure to lower quality bonds to generate similar income.

What are the biggest risks facing loan and bond investors today?

Ian Francis, Director of CQS New City High Yield, said: “Geopolitics will continue to put inflationary pressures on input prices until the level is reached where demand destruction kicks in, which will be a global phenomenon. Central banks will use interest rates to try to stem inflation, but this is a longer term solution and it will take around 18 months to really have an effect.

“There is a growing risk of wage inflation as the workforce tries to secure wage deals close to or above inflation in order to remain solvent. This is not due to greed but to the need caused by very high inflation rates for household fuel and food Credit risk has increased significantly, especially in the past six months, making corporate debt refinancing more expensive than it may has been for a long time.Add to that the bond fund outflows and it makes sense to see tough times ahead.

Gary Kirk, portfolio manager of TwentyFour Select Monthly Income Fund, said: “Companies have been extremely proactive in recent years, taking advantage of ultra-low rates, so medium-term refinancing is very low and balance sheet liquidity looks particularly healthy. In addition, banks’ balance sheets appear extremely robust with excess buffer capital, so the broader economy appears to be in good shape to weather an economic downturn and credit risk is relatively low on a historical basis.

“TGiven this, we think it is fair to assume that the default rate will remain relatively low. Additionally, and assuming that our relative value and due diligence process will minimize the risk of default, I would say that the greatest risk our investors face would be the volatility in market valuation resulting from any general change in sentiment. investors.

What is your company’s ESG approach?

Pieter Staelens, portfolio manager of CVC Income & Growth, said: “Because the company invests in debt, loans and CLOs, we do not have the same influence as equity investors as the positions we hold are non-voting positions and we do not have no ability to influence the management team.That said, we consider ESG factors at several stages of the investment process.

“When selecting investments, we consider material and material ESG and responsible investment issues as part of the overall due diligence process, which may include the use of proprietary and industry-developed questionnaires. Our analysts also use information collected from third-party data providers to assist in the initial identification and review of material ESG factors.

“Recently, the board appointed an additional non-executive director with expertise in ESG issues, following which the company established a dedicated ESG committee. The committee focuses on developing and reviewing strategies, company policies and performance with respect to ESG matters generally, identifying ways to make improvements in these areas, and providing meaningful and appropriate reporting to investors.

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