Manager Views – May 2018

The main topic at this juncture is the significant disconnect between the fundamentals of the companies in which we invest and the pricing of the underlying securities.

The earnings season is close to completion and – almost without exception – the companies we hold are looking more robust from a credit perspective with balance sheet strengthening ongoing. However, prices have recently dipped due to political worries in Italy and Spain rather than because of any specific news about our holdings.

While the inherent nature of our strategy is that it invests in very secure companies offering a steady income, we are at pains to remind investors that downdrafts of around 3%-5% are all but inevitable from time to time. Yet, mean reversion tends to follow quickly as prices bounce back because we are essentially coupon collectors and the yields of the securities we hold are very appealing to income-hungry investors.

This factor should, and has, endured far beyond any period of turbulence and we often reiterate to investors that an accruing yield of 0.0164% per day, which doesn’t sound very interesting, equates to an income stream of over 18% over three years.

Remaining focused on what is truly important – The strength of our companies – and recognising that much market news or noise can have a more lasting effect on currency or equity markets than on our individual holdings, beyond a few weeks, allows us to take advantage of opportunities.

For example, a leading Spanish bank has seen its March issue of a 4.75% coupon bond fall below a price level of 90. Consequently, it now offers a yield-to-maturity of around 6.5% over seven years, which is hugely compelling given its credit quality.

We remain conservatively positioned in terms of issuers (no exposure to Italian banks), capital structure and type of bonds because we are acutely aware that prices do adjust sharply during periods of risk-off inspired turbulence even though we expect the current political clouds’ effect on markets to pass – in Spain, for example, three out of the four political parties want to stay in the euro and the country is benefiting from a strong economic tailwind mitigating worries of contagion from Italy. In addition, the diminishing expectation of strongly rising short-term rates in Europe and in the US means that yield spreads on our holdings are also looking very attractive in nominal terms.

In summary, prices will always oscillate from time to time, but strong companies paying attractive coupon income provide steady returns over time.

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