Macro signals — early signs often come from the ground
John Pattullo, Co‑Head of Strategic Fixed Income, explains how the team arrive at a decision to include a particular bond in their portfolios.
Investing in bonds is a fairly complex process; bonds tend to be bought and sold in a closed world of experienced insiders and experts, but as with any good investment, extensive research is needed before the decision to purchase.
Gathering information about the entity issuing a bond is a lot easier for government bonds than for corporate bonds, as the former market is much more liquid and transparent, with issuer information more easily available for analysis.
Buying a corporate bond is analogous to buying into the business
In order to invest in a corporate bond, detailed scrutiny of the issuer’s business is vital to get a better understanding of how it functions, who its competitors are and its position within the industry and the economy as a whole. As investors, we need to be sure that the company can produce free cash flows regularly, giving it the ability to meet interest payments (coupons on the bonds) and to repay the debt at maturity.
This involves the examination of the issuer’s business through many avenues, which can include company filings (if it is a public company), research material, broker analysis reports, news and, at times, meetings and calls with the company itself.
As strategic bond investors, we are actively on the lookout for opportunities to invest across developed economies in both government and corporate bonds. Our macro asset allocation decisions determine the tilt of the portfolio towards the fixed income asset class most likely to benefit given where we are in the prevailing economic cycle. Government bond purchases are made based on our views of their economies, central bank policies and where inflation and interest rates are heading. Overarching industry views further help the asset allocation to corporate bonds. Individual corporate bond purchases are made after we complete our bottom-up company and security analysis.
Evaluating corporates – the information sources
While information on any one business is not always easily available to the general public, as fund managers we can draw on valuable sources to get the necessary input for our analyses:
- Equity meetings: companies can raise capital via stocks or bonds. If they have issued public equity there will be a plethora of reports and analysis on their business. Our equity analysts have many meetings each year with both companies and industry analysts. The latter group visit companies on a regular basis, and share their information with other market participants, including us. This information is then shared internally with all investment professionals.
- Conferences: each year, numerous conferences are held covering macroeconomics, fixed income (eg, high yield), industries and sectors (eg, technology) and equity-related subjects. As fund managers we have a long list of invitations to attend these, which we do selectively. The forums can be very informative on current issues as well as on future trends.
- Roadshows: investment banks bringing new bond issues into what is known as the ‘primary market’ often organise ‘roadshows’ to invite prospective buyers, including us, to meet the company and its management and provide up-to-date information on its business. The roadshow helps gauge interest in the bond, and our response (and those of other investors) can help to determine the bond price.
- Third-party brokers: through meetings and conference calls they disseminate current information about corporations (and governments) as well as bonds in the ‘secondary market’ where they are traded after issue, via regular reports and analyst meetings.
- Credit rating agencies: if a company has a credit rating in place or has issued bonds, the agencies will continue to monitor it, providing regular reports on the entity with whom they meet to gain an informed view of the company (they also cover governments).
An ear to the ground
While not strictly necessary for any single bond purchase, we selectively meet with a diverse number of companies over the course of the year, whether we hold their bonds or not. This can unearth information and often confirms macro signals at the ground level. For example, with regard to where inflation might be heading, what are companies saying about raising prices? Will they raise them? If not, what is stopping them? Hard facts such as these can paint a clear picture of the economy. Furthermore, optimism or pessimism is typically betrayed by companies when we meet them face to face making this type of direct engagement potentially helpful in our active management of the portfolios. In fact, some of our top-down asset allocation decisions can come from directly meeting with companies.
Once a bond is issued, a further resource for our continued monitoring is the issuer’s quarterly investment calls, where investors get to hear about the current state of the business alongside the official reports that it has to file for the regulators. The live Q&A session is often the most revealing part of the call.
Continuous monitoring is vital
As active fund managers, we continuously monitor the markets and the holdings within our portfolios using the resources mentioned. After we buy a bond, it can stay in the portfolios while it is performing, unless a better opportunity presents. However, if the issuer’s credit story changes or there is a material deterioration to the business, then we act swiftly to sell. We continue to analyse the companies 'long-distance' and prefer not to get emotionally attached to any one name.
We said at the start that macro considerations define our asset allocation decisions. Currently, we believe that markets and economies are definitively in their late-cycle stage and that growth and inflation have peaked; quantitative easing has faded and the short-term cyclical impulse to propel growth over the last two years (such as ill-conceived tax cuts in the US) is also disappearing.
Hence, we continue to be highly selective when adding bonds to the portfolios, looking for defensive, non-cyclical businesses with longevity — or a reason to exist, as we like to call it.
Where to look now?
Given where we are in the cycle, it is becoming increasingly challenging to find credit positive stories, but new pockets of opportunity are always emerging and we spend our time using our resources to seek them out.
As examples, currently we like tower companies and data centres. Why? Towers are critical communication infrastructures, with great revenue visibility. Mobile companies need to lease space on towers to build their networks, which means that tower companies can lock in long-term customer contracts.
Data centres are like a modern day utility. Once again, there is strong demand to lease space in data centres. The demand initially came from connectivity providers, such as BT or AT&T, and then from platforms, such as Amazon. In the future, more demand should come from companies across multiple sectors looking to transition their IT infrastructure from in-house to the cloud in order to save costs, giving data centres a stable base of contracted, recurring revenues.
Portfolio positions are correct at 31 December 2018 and may be subject to change.