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| Andrew Holmes |
Holmes, a director at Schroder Investment Management in London, is product manager for the firm's £2.5 billion in euro-denominated bonds. Overall, Schroders had about £21 billion in fixed income under management as of the end of June. What is Schroders' investment style?
Schroders aims for consistent outperformance with low volatility around the return on the benchmark. We therefore offer investors products whose performance is consistent with the benchmark so there are no big surprises in any particular period. We achieve our consistent performance through processes that identify where we can add value, in effect pick winners, and by taking numerous small positions versus the benchmark. We avoid large bets as these will inevitably lead to high volatility over time.
Is the eurozone a good place to invest in 2005?
We believe the eurozone provides a bond-friendly environment for 2005. We expect economic growth to come in around 1.6%, which is lower than the 1.9% growth recorded for 2004 and, as a consequence, we don't expect the European Central Bank to raise rates this year. This view is contrary to consensus, judging from the Euribor futures contracts which are pricing in one to two rate rises from the ECB by year end. While the ECB's growth estimate is above ours at 1.9% and officials have voiced concerns about the potential for rising inflation, we expect inflationary pressures to moderate and the strength of the euro to persist, creating sufficient monetary tightening for the ECB to hold rates steady for the time being.
How are you positioning yourself in governments versus corporate bonds?
We're moderately overweight European corporate bonds. The economic environment is good for corporates given we'll be seeing continued global growth albeit at a lower pace than in 2004. Companies have been deleveraging their balance sheets and default rates are extremely low. Consequently, we expect to see robust cash flows, which should support spreads at current levels. Technical conditions in the market are also highly supportive with limited supply and very strong demand.
In addition, we have 23 dedicated credit analysts globally and this allows us to pick issues where there is upside value based on credit fundamentals. It is certainly true corporate spreads are close to historic tights. We believe, and periods such as the mid-to-late 1990s confirm this, spreads can remain at these levels for a considerable time. That said, current spread levels certainly warrant caution as there is clearly more downside risk from spread widening than upside potential from spread tightening.
Are you considering investing in derivatives given the tight spread environment?
We are planning to expand our use of credit default swaps from the current limited number of funds in which they are employed to our broad range of bond funds. We've undertaken intensive organizational and legal preparations to this end, and hope to start this wider usage in the first half of 2005.
Where on the credit spectrum do you see the best investment opportunities?
We're looking for a combination of capital gain and yield pick-up, given our view that rates in the Eurozone will likely be stable for a considerable period and global growth will be supportive. Within the corporate sector, we are focusing on lower-rated corporate credits. At the top end of the credit spectrum there's little point investing in triple-A rated corporates when they are trading almost on top of similarly rated sovereigns, as they are now. The triple-B sector offers selective value and we have an out-of-benchmark position in high yield where we are particularly focused on the double-B sector given the potential for some of these companies to be upgraded to investment grade.
What jurisdictions are you focusing on in emerging Europe?
One of the important investment opportunities we've identified for the coming year is the convergence in spreads between the debt of accession countries to the European Union and the Euro, and existing EU sovereign debt. We invest, for example, in the hard currency sovereign debt of Bulgaria and Romania and the local currency sovereign debt of Poland and Slovakia, all of which still trade at quite a decent spread to Eurozone sovereign debt as a whole. We expect these spreads to tighten significantly in the coming 12-18 months.
What is your view on the pending use of Fitch Ratings in Lehman Brothers indices?
It's a positive in that it will dampen volatility in the credit markets. It takes the spotlight off any one rating agency's decisions. For example, in the case of General Motors, Standard & Poor's spooked the market in January when it said it would accelerate its review of the rating, even though there was no change in the company's fundamentals.
How are you positioned with regards to GM?
We're broadly neutral and watching developments in the market. Although it is possible S&P will downgrade GM in 2005, Moody's Investors Service's higher rating and the inclusion of Fitch in the Lehman indices gives us comfort they will likely remain in the investment-grade indices this year. In the meantime, 10-year GM bonds are currently trading at an option-adjusted spread of 320 basis points versus 69bps for the Euro triple-B sector as a whole. GM bonds are, however, very volatile indeed, and that additional volatility needs to be sufficiently compensated for by incremental carry.