Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm here today joined by Ian Spreadbury, Manager of the MoneyBuilder Income Fund.
Ian Spreadbury: Hello Emma.
Wall: Hello there. So, you've been running bond funds for 20 years with some success, it should be added. MoneyBuilder Income is a Gold-rated fund by Morningstar fund analysts. What do you say to the people given that you have that long experience who say that we are now in unprecedented time for bond investing that we've never seen a market like this before?
Spreadbury: It's true to some degree. When I launched MoneyBuilder Income 20 years ago yields were about 8%. They are now 3%. So, over the last 20 years we've seen great performance from bonds and bonds have done a very good job as an equity diversifier. Over that period equity performance has been pretty volatile. I do think inevitably given where yields are at the moment that returns from bonds will be a bit lower going forward.
But I'm very much in the slow growth low inflation camp and so I still think we can see decent bond returns going forward and I think bonds should continue to do a good job in terms of being less volatile than some other asset classes like equities being a good equity diversifier and also throwing off albeit a more modest level of income relative to cash still not too bad.
Wall: Fundamentals look as if that we are going to be in a low growth environment not just for bonds but for equities too. The developed market equity run that we've seen over the last five years can't really continue indefinitely. One of the things that's threatening bonds in particular is the threat of an interest rate rise. I mean, are you worried about that? Is that something that's looming over the horizon or is it just one of those things that's headline grabbing?
Spreadbury: I think it is something we'll likely see, but to some degree it's been discounted by the markets already. Again, I think the authorities are pretty concerned about this extraordinarily low interest rate environment. I think they are worried about the impact of ultra-low interest and the QE that we've seen on the economy going forward.
So, for example, we've seen a widening in the wealth divide. We're in a situation where arguably poorer companies are being helped to stay afloat and things like that are not necessarily good for the economy going forward. So, I think they would like to see rates going up a little bit.
Growth and inflation have surprised on the downside pretty consistently over the last few years and I think that may happen going forward. So, I think they would also like to build up some ammunition to hike rates a little bit if only to have some firepower to cut them if growth and/or inflation were to surprise on the downside going forward.
Wall: Are you still seeing ample opportunities, ample investments in the bond market because one of the sort of strange things that's happened over the last couple of years with huge amount of QE that's been pumped into the system is there seems to be a disconnect with some government bonds in particular between how risky a particular bond is and actually the yields that you can get on it. So, with that in mind, are you finding opportunities, perhaps less than you were before, but going forward?
Spreadbury: I think there are still opportunities in the bond market in various areas. I think you have to remember the long-term driver of high-quality bond yields is nominal growth. So, I'm still very much in the low growth low inflation camp. So, corporate bond yields 3.5% for BBB high quality bonds is actually not too bad and I think it's in line with the economic environment. So, I'm pretty happy. So, I'm still finding decent opportunities.
We had a recent deal for Center Parcs, for example, a great credit but on a yield of about 1.5% over and above government bonds. We recently had a deal for Imperial Tobacco in dollars, for example, again on a yield of about 2% over government bonds. So, in corporate bonds there are opportunities. I mean, I guess to a lesser extent in government bonds I think there may be some opportunities in emerging markets. But I'm pretty cautious and certainly our MoneyBuilder Income Fund is very much focused on investment grade rather than high yield.
Wall: And then putting the yielders to one side then looking at investment grade, when we have economic growth, when we have improving economic outlooks, you often see an uptick in M&A and that is a positive thing for equity investors, but it is a positive thing for bond market investors as well. Is that something that you are looking to take advantage of?
Spreadbury: It can be positive. For example, when Verizon took over Vodafone's mobile assets last year they issued I think what was the largest ever corporate bond deal. I think they issued $49 billion in one day, but they had to pay up for that. So, as an investor we had the benefit of that higher yield. It can be a negative if a company leverages and if you are already in the bond, but that's our job at Fidelity really to be on the right side of that leveraging.
Wall: And just taking a minute about diversification, because you did say at the beginning that bonds play an important role in diversifying from equities within an investor's portfolio which of course they do. Wherever the opportunity set is you should always have diversified asset allocation. What about then diversification within the fund because you have talked in the past about the importance of holding a cash buffer for that reason?
Spreadbury: I think it's important to diversify to get the right risk/return balance and to avoid being over-concentrated in the fund. For example, at the bond level in investment-grade bonds arguably risk is asymmetric. So, if a company goes bust, you could lose everything. But on the other side, if things go well, you clip your coupon and the capital upside is pretty limited. So, in bonds, it's incredibly important to diversify. So the largest holding in my investment-grade portfolios would be say 3% of the portfolio.
Also, at the sector level, for similar reasons it's important to diversify. So, I'm pretty diversified. I am quite worried about the economic environment. Again, I think we've got this massive structural debt problem globally that I think is bearing down on growth. So, there is a downside risk and I am very much focused on high conviction companies, bonds with asset backing, bonds in areas like regulated utilities, non-cyclical food, drink and tobacco type sectors and it is important to diversify.
Wall: The safest of the safer assets?
Spreadbury: Well, it's always a balance between getting paid and safety and getting that right risk/reward balance and that's what I'm trying to do in the fund.
Wall: Ian, thank you very much.
Spreadbury: Pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
