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| Sajiv Vaid |
Royal London Asset Management will increase its weighting in credit by up to 3%--or £140 million--if spreads on high-beta bonds widen out by another 10 to 20 basis points, which the manager thinks is likely in the coming months. Specifically, RLAM is looking to add to sterling-denominated subordinated financial and triple-B industrial paper, said Sajiv Vaid, portfolio manager for investment-grade corporate bonds in London. RLAM has £11 billion in fixed income, £4.6 billion of which is in corporates benchmarked against the iBoxx sterling non-gilt index. Vaid is positive on riskier names because he believes the recent spread widening does not reflect a deterioration in fundamentals. "The back-up in spreads now is a function of the market correcting, not of any fundamental change to default rates or company leverage," he noted. Market sentiment remains panicky and the correction still has a little way to go, according to Vaid, but he expects to be stepping up and buying selectively in the next month or two.
The fund manager is looking to add money to Tier I and upper Tier II financial paper, increasing RLAM's 4% overweight in the sector. "We'd stick with the high-quality U.K. and Nordic banks which have strong domestic franchises and a focus on the mortgage sector," commented the manager. Meanwhile, he would stay away from U.S. brokerages.
Vaid also has his eye on industrial names rumored to be leveraged buy-out targets. "Far more rumors are in the market than actual buy-out opportunities, and a manager who does his homework can make money on the spread widening that results from LBO fears--assuming the company does not actually get taken out," noted Vaid.
Vaid gave U.K. auto parts maker GKN Holdings, U.K. engineering group Tomkins and electricity company Scottish Power as examples of companies where spreads have recently been driven out by 30 to 40 basis points. He said there is actually a low probability of an LBO in these companies due to pension deficits, regulatory or other mitigating considerations. Vaid stressed the importance of evaluating not only the likelihood of an LBO, but also the protection afforded bondholders in the event of an LBO. "In the case of [U.K. mobile phone company] mm02, which was rumored to be an LBO candidate a couple weeks ago, the step-up bondholders would get in the event of a downgrade to junk would be enough to compensate for the increase in risk," said Vaid.
On the flip side, RLAM will fund its increases by selling better-quality names, such as Proctor & Gamble and WalMart, which have weathered the recent increase in volatility well.
