by Jake Moeller.
Lipper’s Jake Moeller reviews highlights of a meeting on March 30, 2015, with Jenna Barnard, Co-Fund Manager of Henderson Preference and Bond Fund.
This 2015 U.K. Lipper Award-winning fund is affectionately described as “bread and butter” for many financial planners. With over £670 million in total net assets, it has been around since 1978 and has a loyal following of advisors and investors who seek income in the retirement phase. Managed by both Ms. Barnard and John Pattullo for 12 years, this is the sister fund to Henderson Strategic Bond Fund (which also sits in the strategic bond fund sector) but has less of a total return focus than its sibling.
This is a fund with a strict income priority. The average age of the investor base is 75, and – unusually for many fund managers – such a highly homogeneous group allows the managers to specifically adapt their portfolio. “We constantly seek ‘sensible’ yield,” Ms. Barnard states. “Our distribution yield is currently 5%, and with the risk-free rate so low we are in a very challenging environment. We don’t want a yield target of 6% nor buy poor quality to achieve it.” Indeed, Ms. Barnard unapologetically describes the fund as “unfashionable” in the context of the increasing tendency for the market to invest in the more dynamic unconstrained bond funds; the main aim of this fund is to fish in the BBB/BB pool – a strategy largely unchanged since 2009.
Table One. Multi-Period Performance of Henderson Preference & Bond Fund Versus Peer Group and Various Indices (as at April 30, 2015)
Despite technically being a “goes anywhere” fund, the broad asset allocation ranges the sector permits are rarely used. The fund has a long history of investing in sub-ordinated financials (currently 44% of fund split evenly between investment grade and high yield with the majority of high yield financial rated BB credit). And while there is a high degree of technical and macro analysis undertaken by the Henderson fixed income team, Ms Barnard points out that the process more simply distils down to good stock picking in BBB/BB credit and getting a confident view on interest rates.
“Our unique client base means we have a very low degree of attrition in volatile markets,” says Ms. Barnard, this means that – rarely being forced sellers – Ms. Barnard and Mr. Pattullo can ride out difficult periods and pick up good credit at decent prices. In an enduring environment of low growth, inflation and defaults where carry is predominant, this can be a valuable tool. During the “taper tantrum” of May 2013, the Automobile Association issued bonds at 9.5% in order to attract investors. The duo was readily able to pick these up at issue while others ignored them in the sell-off. These bonds recently refinanced in March 2015 at a coupon of 5.5%. “This was a very good acquisition for the fund,” states Ms. Barnard, “good quality, utility-like with lots of cash flow. Some investors ignored them because of the financial leverage (7.5x), but we preferred this to a ‘safer’ energy company with illusionary 2x leverage that becomes 6x when the oil price falls.”
Table Two. Performance Chart of Henderson Preference & Bond v Peer Group within Quartiles (to April 30, 2015)
Similarly, credit re-ratings offer another opportunity for the fund managers. They were buying Tesco in February 2015 shortly after its debt had been downgraded to high-yield. “This was a strategic decision by Tesco to avoid a rights issue and the bonds sold off aggressively,” states Ms. Barnard. “We started buying; the credit story stacked up. There are a lot of easy disposals Tesco can make to raise cash and if the operational turnaround happens, this will provide even better support.”
Ms. Barnard and Mr. Pattullo have made some accurate recent calls on interest rates, which have held the fund in good stead. They were long duration for most of 2014 – a position they maintain: “We are not sure the Fed will raise rates this year,” states Ms. Barnard. Low inflation and negative PPI in China are cited as support for this thesis, with the U.K. – although experiencing an increase in growth is tempered by below target inflationary forecasts for the foreseeable future.
Table Three. 3-Year Risk/ Return of Henderson Preference & Bond Fund Within Sector Classification (to April 30,2015)
The fund can invest in derivatives – a strategy that returned 60 basis points of return for the fund in 2014, but this is done only where there is a clear opportunity. Recently, Ms. Barnard closed out a short-euro/ long-dollar position that had done well and was opened because of a high- conviction view on the effect of negative interest rates on “Quantitative Easing.” The fund however, isn’t as flexible here as is its sister fund, Strategic Bond. Credit derivatives pay no income, so hedging with them means sacrificing income in the fund. Ms. Bernard points out: “This fund will not do as well as Strategic (bond fund) in a rough market. We deliberately keep our cash balance lower and can’t undertake super-defensive transactions to lower our income.” A longer-term view means that often investors will have to ride out marking-to-market but here the managers would be clearly helped by their sticky investor base and, following the May 2015 shake out in sovereign markets, the managers have recently reduced duration to 4.6 years.
The strategy of this fund is constructed around a disinflationary outlook. There is a preference to lock in long-dated yields to avoid re-investment risk, so within investment-grade credit the managers procure 20-30 year maturities and “stamp collect” older legacy tier-one bank bonds. This enables them to secure yields of around 5.0%-5.5%, which they think is reasonable in such a benign environment.
Ms. Barnard does point out, however, that the biggest risk to the fund would be in the unlikely event of a “taper tantrum” where government bonds and equities sell off at the same. This could come about if Federal Reserve Chair, Janet Yellen, were to raise rates more aggressively (and earlier) in the cycle than investors expect. The proven track record of these experienced fund managers in some of the most difficult credit markets in recent history, has no doubt contributed to the extremely loyal following the fund has garnered.
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This material is provided for as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice. The author does not own shares in this investment.