Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall, and I am joined today by Christine Johnson, Head of Fixed Income for Old Mutual Global Investors to give her three bond picks.
Hi, Christine.
Christine Johnson: Hi, there.
Wall: So what's the first bond, you'd like to highlight today?
Johnson: So starting in at the deep end, it's a company called FMG, Fortescue Metals Group. They are the second cheapest iron ore producer in the world. Now, I know commodities have not had a good time in the last few years, but that's why it's now time to start looking at them.
What we really like about Fortescue is their ability to control their costs. What they have managed to do is to bring down their cost of bringing every ton of iron ore actually to the market. They have brought that down by more than 50%. That means they are starting to generate cash.
So, if you are bond investor, what you are really interested in is, can this company actually start to generate cash at the bottom of the market. So they have brought down their per ton cost to 25, the iron ore cost now is actually 60, so they are producing plenty of cash. What are they doing with that?
Well, they do have quite a lot of expensive bonds outstanding. They have a bond for example with the 9.875 coupon, that's a lot of money for them to prepay in that coupon. So what they are doing is they are starting to tender for those bonds and they are starting to buy them back. So even now we've had some performance in these and we've done really well by being kind of a little bit brave and a little bit ahead in terms of getting invested, but even now we're seeing value because if they tender for them, great you get major upside, but if they don't you're still getting paid at that 9.875 coupon.
Wall: I mean you've caveated there with being bold and being brave, but most people would say commodity is terrifying place to be. I suppose it's about picking the quality bonds, because there's a lot of junk out there.
Johnson: There's a lot of junk out there, but what it meant was when we had the sort of general panic last year was you had lots of good things getting thrown out with lots of bad things. So, it's the case now exactly of just going through and say, okay so who probably deserves to have been thrown out and who actually like FMG are able to flex their business model and survive through this, and therefore can I take advantage of indiscriminate selling.
Wall: And your second bond pick is another quite punchy one as well, isn't it?
Johnson: Absolutely. It's Brazil which sort of last year, it was beyond redemption. It was just seen as appalling country with loads of problems with whether it was inflation, whether it's their dependency on oil, whether it was the corruption problems. But we looked at Brazil and we remembered what happened to Iceland. Iceland is now a great country, it has 6.5% growth. It's a fantastic country. But if you remember seven, eight years ago, Iceland was again it was untouchable, it was considered to be…
Wall: We had to bail them out with the savings accounts.
Johnson: We had to bail them out. So it's looking now the most hated and actually thinking, well, perhaps if all the bad things don't come true, there is another reality where this country can actually start to claw its way back. There is definitely a sea-change in Brazil where they want to get rid of corruption and they want to move on from the past.
So, again for Brazil, we're looking at bonds which are relatively short-dated. They have a 14.5% yield. So, even if they don't move up in price, I'm happy just taking the yield, but our anticipation is that central bank will actually start cutting rates and we should get price appreciation as well as the yield.
Wall: And for those people, who are perhaps not as brave to take the first two picks, what's your third?
Johnson: I could understand they might not be for everyone. So, right at the other end of this scale, I'm going to say the U.S. two-year Treasury bond. It doesn't sound very exciting. But when I tell you it's got a yield of about 85 basis points and that gives you a breakeven. That means how much you could withstand in terms of yield rises before you lost money. It's got about 75 basis points breakeven. If you just want to buy and hold, well you get a positive return. You know you are going to get your money back. U.S. two year looks pretty good.
Wall: And those three picks do help to paint the picture of very diverse bond market, which I think a lot of people don't realize sometimes. They think equities of course, they can be heterogeneous, but bonds they are all the same, definitely not the case.
Johnson: Definitely not the case and it's really a world where you want to think about asset managers. I understand completely, if someone is going to bypass it, but if you want to look across the whole piece and say where can I get value, where can I express view, then you have to start thinking about active managers and probably strategic mangers who can make these choices.
Wall: Christine, thank you very much.
Johnson: Thank you.
Wall: This is Emma wall for Morningstar. Thank you for watching.
