This article is part of Morningstar's Guide to Financial Education
Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and here with me today is John Pattullo, co-manager of Henderson Strategic Bond Fund.
Hello, John.
John Pattullo: Hi.
Wall: So, we are here today to talk about three fixed income opportunities. What's the first you have for us?
Pattullo: The first one is so called legacy tier 1 bonds. So we hold quite a lot of the old style junior banking bonds which were issued many years ago. Interesting thing about these is they are using their regulatory capital. So they are not loss absorbing under new regime. So if a bank goes bust generally these bonds have to – the new bonds, the loss absorbing bonds either get turned into equity or get wiped out.
These old bonds doesn’t happen to. So the banks are keen to buy these back, but we are not keen to sell them back to them and hence they trade very well, they are very sort after. We've locked in some great yields, with reasonable maturities for the clients. And the recent sell-off of the so called CoCos, the new bond, these bonds didn’t really sell-off at all which is great because they are quite yielding and not volatile.
So we think these are very attractive, still got some merit, but they are maturing slowly but they are quite hard to come by because people like ourselves have got them locked away for the clients.
Wall: So this is sort of a supply and demand story then?
Pattullo: Very much so. These things – there is no new supply of these things some are getting bought back by the banks which is fine, but it is up to us, if we want to sell them back and at what price. And frankly we'd rather just keep them for the next five or 10 years to the benefit of our clients.
Wall: What's your second opportunity today?
Pattullo: Second one is mobile phone convergence. I'm sure you've noticed that your 3G is probably not great whenever your travel, 4G is getting there. But generally the European regulators are sympathetic to some or many mobile phone markets moving to a three player market, whereas in Europe generally most countries have four players. So we've noticed this trend in Ireland, in Germany and potentially many other countries.
The regulators are sympathetic to muffle market repair it's called. Because essentially operators have to invest in 4G, we all want 4G, we all want data, someone's got to pay for it and generally when large investment grade companies buy smaller high yield mobile phone business, you see that bonds trade up as you'll expect and we've been very well positioned in that trade. And I think that’s a global trade which could continue for many, many years. Telecom convergence in Europe is a hot topic as is global convergence.
You're also seeing quite a lot of convergence of cable TV businesses with mobile phone businesses and vice versa. There has always been the third, which isn't our third one, but the third trend of the convergence with content as well. So ITV, for example, is well rumored bid, so that's interesting as well. So the convergence in mobile phones, I think is highly topical.
Wall: We've already seen that a little bit happening with the forming of EE, T-Mobile and Orange coming together, so that's just a start. Isn't it?
Pattullo: No, exactly and Hutchison Whampoa (00013) who owns 3 are rumored that they may actually consolidate even the U.K. into a three player market. It's not happened in the States; Sprint was looking at buying T-Mobile, that's not been allowed by the regulators. In five years' time, I think there will be three players in the States as well.
Wall: Then your third opportunity today?
Pattullo: Yeah, third one is actually a rather dull one, so it's stick to the netting. We're quite late in the credit cycle. We don't want to get carried away. We don't want to lend to the latest overleveraged, leveraged buyer. So we're very much trying to stick to good, reliable sensible businesses and we have – there's a really three thing, where many industries consolidate down to three and not just mobile phones. And a good one is motorway service assistance in the U.K., so the AA (AA.) and RAC, I would suggest a pretty similar organizations. So I'm sure they would hate me saying that, but essentially they are.
We actually lend to both of those organizations because they don't compete in price. They are an oligopoly, not competing on price, competing on brand. Both are well-run, both are quite levered, both are well managed, perfect bonds in our opinion. So we lend – one's a loan, one's a bond, but it doesn't really matter. But if you can get an industry, which is heavily consolidated, competes on brand and not price as a bond holder you shouldn't get many surprises and you should get a good coupon for your investors.
Wall: Plain vanilla or investing?
Pattullo: Well, it's just sensible. I mean, to be fair to those companies are quite levered, but their stability of earnings is the attraction for us and I think that's what we're trying to do. We know it. We understand it. Some of us are customers. We kind of get it and I think that makes a lot of sense at this time in the cycle.
Wall: John, thank you very much.
Pattullo: Thank you.
Wall: This is Emma Wall from Morningstar. Thank you for watching.
