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3 Bonds That Aren't as Risky as You Think

VIDEO: Fidelity's Sajid Vaid explains why sometimes a bond can be appealing when the company's stock is not

Holly Black 12 November, 2019 | 11:54AM

 

 

Holly Black: Welcome to the Morningstar series, "3 Stock Picks." I'm Holly Black. With me is Sajiv Vaid. He's manager of the Fidelity MoneyBuilder Income Fund. Hello.

Sajiv Vaid: Hi, Holly.

Black: So, we're going to talk about three areas in the portfolio you're quite excited about at the moment. Where would you like to start?

Vaid: One area where we have a big exposure to the funds is an asset-backed or secured bonds. And within that is one quite topical bond, which is Intu which is the landlord of some of the major retail parks in the UK And I think this was a good example of the difference between an equity and bond holder. As an equity holder, a lot of headwinds that we as bondholders recognize in terms of problems on the retailers, problems on income visibility and earnings, all those issues. However, as a bondholder we're secured on specific assets. So, in the case of – we are secured either on topically as Metro Centre, which is in Gateshead or Lakeside in Thurrock and Essex. And within that, we also have covenants, financial covenants, protecting us as bondholders. So, we're not necessarily looking at the upside. We're looking at the downside. And when we look at the downside, we're getting just under 6% yield a four-year bond. So, that's priced like a junk bond, but it's investment grade. And also, most importantly, if our investment thesis is wrong, what's the recovery rate? And these bonds are trading at 90p in the pound. We feel that in case it defaults, the recovery rate is significantly greater than that. And that's an opportunity we have in the fund, represents just under 1.3% of our fund.

Black: That is really interesting, because that is an area a lot of people would be steering clear off at the moment.

Vaid: Yeah. And I think it's absolutely – one of the hardest things as a bond manager, or any manager for that sense, when you look at the headlines, you understand the news flow is going to be negative. The key question you have to ask as a corporate bond manager, am I paid for that risk? And it's never 100%. But if you go a long way to compensating for some of those risks, it's something that you should start to deliver to your clients by putting in the portfolio.

Black: Excellent. What's bond number two, then?

Vaid: Bond number two is actually within the utility sector, in the UK utility sector. Again, an area where given the potential election in the UK, nationalisation risk, et cetera, one would want to stay away from that. But actually…

Black: It's like you're picking all of the dodgy areas.

Vaid: Yes. I think one of the key ones within that is actually Thames Water. So, that is a company where it's been on the naughty step for a long time in terms of operation, et cetera. But those bonds are yielding 2% over government bonds in the longer end, and we believe for the regulated nature of it, the noncyclical cash flow, that these are actually good instruments to have in the portfolio.

Black: Excellent. And what's our final pick?

Vaid: Final pick is more global. So, obviously, over the last few years, there's been a lot of M&A activity, so companies leveraging up, et cetera. So, the key thing from a bondholder's perspective and using our team of analysts is, identifying which company we have confidence that they will be able to delever. Because a lot of companies will say they delever, but because of the economic climate cannot. So, a good example of that would be InBev. However, within the global payment services industry, so that's FIS, they bought Worldpay, FISV that they bought First Data. They've levered up from 2.5 times to just under 5 times, so quite highly levered. But they have a history of acquiring and delevering. And our analyst is confident that they can delever that entity because many of their cash flows are noncyclical,

Black: And reducing leverage is better because it's more likely to repay you.

Vaid: Exactly, exactly. Thank you.

Black: Well, thank you so much for your time. And thanks for joining us.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Holly Black  is Senior Editor, Morningstar.co.uk

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