United Kingdom
Damien Hill, senior portfolio manager for the Responsible Horizons UK Corporate Bond strategy and the Strategic Bond strategy gives an update on UK corporate bonds.
What is your scenario for the investment cycle over the next 12 months?
Our current economic view is supportive of risk assets and corporate bonds over the next several months, so we maintain structural over-weights to corporate bond markets. However, we have reduced overall risk somewhat as the direction of economic growth, inflation, and interest rates has become less certain. However, we believe volatile geopolitics will continue to create opportunities for active management. Plus, core inflation driven by services and wages is likely to stay more elevated for longer meaning the quantum of interest rate cuts possible from the major developed market central banks is less than what many market participants are forecasting. In this backdrop, we expect demand to remain strong for fixed income given overall yield levels provide both attractive income and capital gain potential versus other risk assets. In corporate bond portfolios we are favouring an increase in quality bias by overweighting investment grade relative to high yield given we expect the themes of geopolitical uncertainty and market volatility to persist in the medium term.
Higher yields for investment grade bonds are bringing higher demand. What are the consequences of this?
Credit spreads have performed strongly but we still think market momentum remains strong and outright spreads remain relatively attractive given the economic backdrop. Certain areas of the market that are sensitive to investors who focus on outright yield over spreads have been distorted; valuations of bonds with longer maturities over 15 years (a focus for pension buyers), and global high yield (focus for wealth and retail) have become relatively unattractive versus other areas of investment grade corporate bonds.
What are the practical implications of taking ESG factors into account when investing in UK corporate bonds?
The factors we target centre around impact, engagement, and exclusion regardless of regional market.
- Analysing the frameworks of ‘use-of-proceeds’ impact bonds can help reduce the risk of ‘greenwashing’. These bonds often used to trade at lower yields to comparable bonds of
the same issuers. This is no longer the case as increased supply has met demand head on. - To engage effectively with corporate bond issuers there are several avenues to take. Insight might engage with an issuer as part of the standard investment process, seeking to
understand the risks and opportunities it faces, and possibly to encourage a company to change its approach on a specific issue. When it comes to impact bonds, we have engaged with some issuers on how frameworks should best be structured to improve transparency and their overall positive impact. - Sectoral exclusions are common in strategies focused on ESG factors. However, avoiding swathes of the market risks becoming overly concentrated and undermining the financial performance of strategies. Our Responsible Horizons strategies apply various exclusions, such as on companies with material revenue exposures to certain ‘red-line’ sectors which include oil and gas, tobacco, weapons among others, but these exclusions amount to a very small proportion of the UK corporate bond universe. We also exclude issuers which we deem to have worst-in-class ESG and climate risk profiles, but we may seek to support these issuers via engagement to improve their profiles. Also, the Responsible Horizons strategies may invest in the use-of-proceeds impact bonds of some excluded companies with a high carbon intensity, as long as the impact bond passes our assessment and where the issuer has a clear decarbonisation strategy.
Please describe the investment strategies you manage.
We have a dual focus on delivering attractive financial outcomes while taking environmental, social and governance factors into account. We seek to emphasise the best and avoid the worst performers on ESG issues. So, we avoid investments in industries that have a negative impact, apply a higher hurdle when considering investments in environmentally-sensitive industries, and harness long-term themes such as climate change.
