Sluggish economic growth and historically low bond yields are pushing investors towards growth stocks and away from cyclical value shares. Growth stocks are bought for their long-term cash flows, which are worth relatively more as yields fall. An equity manager’s performance over the next year will almost certainly depend on whether they get the call between growth and value correct. Managing equities has become much more dependent on top-down judgements.
While equity managers are struggling with the polarisation between growth and value stocks, bond managers like me are wholly driven by value: there is no growth in fixed income (the clue is in the name). But where is the value in bonds now?
Bonds used to be regarded as the safe asset class and UK government bonds (Gilts) as a risk-free return. But the ratio of income to potential capital losses (as yields rise) has reached a level that makes the asset class anything but safe. Globally, government bonds on negative yields (there are still $13trn of them out there) have become a return-free risk.
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So where do bond managers turn to find returns without taking excessive duration or credit risk? This is not easy for bond managers and even harder, I would suggest, for private investors. Corporate bonds tend to be sold with large minimum denominations these days, putting them out of reach for most private investors. One way, however, in which an investor can find a decent yield is to accept some degree of liquidity risk, or look in places where institutional investors can’t invest owing to their size. The UK retail bond market is one such place.
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There are a number of smaller businesses that use the retail bond market to issue bonds in smaller sizes and at a lower cost. Small companies are not necessarily a poorer credit risk, even when they haven’t got an official credit rating. If you have the time to look at these companies carefully, you can find many with reliable cash flows established over long periods and comfortably above their financing costs. We think this makes them attractive, especially if you buy and hold to maturity – normally for around five or six years.
... in the property sector
We invest in some of these issues on behalf of our clients and to a limited extent in the Waverton bond funds. Our favourite issuers in this market are property companies. One example is Bruntwood. This is a well-established landlord of commercial property in the Manchester region. It has just launched a five-year bond with a coupon (interest rate) of 6%. That is more than ten times the income you will receive on a UK gilt to the same maturity.
Another low-risk property bond issuer is Regional REIT, with a nationwide portfolio of properties, mainly offices, supporting a bond with a 4.5% coupon, although this trades at a 4% price premium so it may be better for those investing through a tax-free wrapper such as an Isa or a Sipp.
Finally, Provident Financial, the sub-prime lender, has a three-year bond with a coupon of 5.125%, which trades at a small discount and gives a total return of around 5.5%. The company has had its problems with the Financial Conduct Authority, the City regulator, but appears to be well on the road to recovery, making these bonds attractive.
