In discussion with IFA Magazine, M&G’s Ben Lord highlights the attractions of investment grade (IG) credit in the current economic conditions and outlines why his team are best positioned to help advisers and their clients to access exciting opportunities in this and more broadly across the fixed income market.
During the conversation, Ben Lord, manager of M&G’s Global Corporate Bond Strategy, suggests that investment grade credit presents a rare opportunity where the usual lower risk, low-return option could be a better prospect than other investments.
M&G’s emphasis on fundamental credit research has helped identify this opportunity which Ben believes could be able to provide investors with greater than expected returns, using the strength of research from M&G’s credit analysts – something which he believes sets them apart from other providers in the space.
Ben and his team are continuing to identify positive investment opportunities in the IG credit marketplace and believe that they have spotted a situation where volatility provides an attractive investment opportunity.
IFA Magazine: Why do you believe investment grade credit offers such a good investment opportunity and why now?
Ben Lord: “We think that now is the time to be adding to investment grade credit as we are currently being paid FOR at least 2x worse than the worst ever level of default that we’ve seen in investment grade.
“Typically, our expectations for defaults within the investment grade market mean we wouldn’t expect anything like that. We should also consider that inflation in the last two years has been positive for companies. Effectively, unless the company is having to increase its level of borrowing by the same rate of inflation or higher, its credit worthiness is getting better, not worse.
“We think that companies are in good shape and we’re being overcompensated for any reasonable expectation of default. Also, in investment grade credit, our corporate bond yield, is a combination of the underlying government bond yields, the risk-free rate, the credit spreads and the risk premium.
“For example, if Vodafone was bringing a ten-year bond today, you take the ten-year yield, that is your risk-free rate, then you add 10-year Vodaphone risk premium, the credit spread, and you get the coupon that the company must pay.
“What I like at the moment with yields is that there is a hedging characteristic. There is a negative correlation, I would expect, between the risk-free rate from the risk premium. It’s a benign outlook environment; spreads are fair value and there is a diversification benefit within investment grade credit of combining risk free rates with a risk premium.”
IFA Magazine: Why should advisers choose M&G in this sector and what differentiates you?
Ben Lord: “As I mentioned earlier, what differentiates M&G, particularly so in this market, is that we have always believed in the value of fundamental credit research, which, in our view, leads to positive investor outcomes. At M&G, we are fortunate in having a very strong, experienced, large team of fundamental credit analysts, mainly based in London, covering pan-European, which is a large part of the global investment grade universe, but increasingly also in Chicago and in Singapore.
“We’ve invested over the last five years in expanding our global reach of fundamental credit analysts. Why is that important in this market? It’s because we see really significant spread dispersion. What that means is, for example, if you are interested in bonds rates as triple Bs, which is where I see the best value at the moment, and you’ve chosen a sector that you like more or you are looking across the whole triple B universe, you might have some names that are trading at government bond yields plus 75 you also have names at plus 700.
“There’s a huge dispersion of spreads within the investment grade universe, and that presents companies like us, with big, strong, experienced teams of analysts, with much more of an opportunity to add value than we’ve seen for many years. I would really put the analyst team at the top of the list of what differentiates M&G, particularly at this point in the cycle.”
IFA Magazine: What opportunities do you see and what is your outlook for fixed income for the rest of 2023?
Ben Lord: “The primary opportunities have been attractive corporate bond yields. Investment grade corporate bonds have the potential to yield anywhere between 3.5% in euros and 7.5% in the sterling and US dollar markets. That’s the major opportunity. Added to that is the fact that the hedge characteristics or the diversification benefit between the risk-free rate and the risk premium, which are combined in an investment grade corporate bond, are really worthwhile at these levels for us as investors.
“In my opinion, barring some very fast-moving exogenous shock, we could have mid-single digit to high single digit returns over several years to come. Clearly in 2023, as we’ve already seen, there is going to be volatility. We’re at this peak central bank hawkishness regime at the moment.
“On top of that, there’s a huge debate about whether there’s a recession coming or not which is adding to volatility. We have to recognise that there will be elevated levels of volatility in the markets, but that this presents challenges, particularly for active managers, both with threats, risks and opportunities. We’re seeing lots of opportunities from the volatility which we’re very well placed to capitalise on.
“In terms of where I expect the market to go in 2023, my personal view is that we are about to witness the expiry of the lag from monetary policy action to real economy reaction. I expect to see the economic data turned down and to see growth numbers fall. Therefore, I’d continue to expect to see elevated discussion and concern amongst investors about the threat of a recession to come. It may sound strange for a corporate bond fund manager to be bullish on the sector when he’s expecting a recession to come. But we think that the starting point in spreads is fair and the starting point in corporate bond yields is really attractive.
“My expectation would be that as the economy slows, we may get some spread widening, but also that at that point we will see risk free rate government bond yields fall. I believe that there’s a good chance that those falls in risk free rates more than offset the widening in spreads. There’s so much expectation around a recession to come that I think quite a lot of that is already in the price spreads.
“The risk to that view is that central banks are telling us that they’re going to keep rates in restrictive territory for a longer period of time than we’ve become used to over the last 15 years. For the last 15 years, as soon as something bad happens, central banks have slashed rates and increased quantitative easing. They’re telling us that this time, with inflation where it is, they won’t respond in the same way. Instead, they will keep rates high and restrictive so as to bring inflation down. The fact is that we don’t know what the effects of the tightening in 2021-22 and early this year are going to have on the economy. We just have to watch and observe and respond.
“My expectation is firmly that the monetary policy still works but with a longer lag than before given changes to mortgage markets. But I also question whether central banks are going to be able to really keep rates restrictive for very long, even as a downturn unfolds.
“It’s going to be a very, very uncomfortable place for central banks to be because they’re trying to get inflation back to target. However, you can’t get inflation at target with wages rising between 4.5% in the US and 6.5% in the UK with Europe somewhere in the middle. You have to see wages falling and that means one of two things, either unemployment rises or companies are too scared to pass on these levels of wage increases. To expect that central banks are going to keep policy restrictive in the downturn is to expect that central banks are going to face down, look into the eyes of all these households worldwide that are starting to lose their jobs and decline to soften that blow and to stimulate the economy in spite of that. Probably, they should have hiked sooner and more aggressively in 2021. In my opinion, they will find that too uncomfortable and will have to start cutting rates.”
I would also like to add the attractiveness of global investment grade funds over sterling or euro investment grade. The global economy is desynchronising, which presents global managers with opportunities between the regions as they move at different times. Furthermore, there are always relative value opportunities between regions in terms of the credit spreads available. Finally, following the LDI crisis in September, I think that many investors should worry about being too over exposed to UK fixed income alone, and could benefit from taking exposures to greater amounts of dollar and euro denominated credit risk, and so reduce over reliance on the volatile UK market.
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About Ben Lord
Ben Lord joined M&G in 2007 and was appointed manager of the M&G Global Corporate Bond strategy when it was launched in September 2013. Ben also manages the M&G UK Inflation Linked Corporate Bond strategy and co-manages the Corporate Bond and Strategic Corporate Bond strategies. Before joining M&G, he worked at Gordian Knot as a credit analyst covering global financial institutions. Ben obtained an MA (Hons) from the University of Edinburgh and is a CFA charterholder.
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