FOCUS: Fidelity Fixed Income

Fidelity fixed income trio Sajiv Vaid, Peter Khan and Kris Atkinson on how the team are rising to the income challenge in turbulent times

Focus is a publication that brings you face to face with a selection of the most in-demand asset managers in the UK and across Europe.

Running a suite of diverse products across the fixed income universe, Fidelity’s Sajiv Vaid, Kris Atkinson and Peter Khan are one part of an extensive team of 70 investment professionals focusing on this asset class at the group.

IN THIS EDITION

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In this guide, we explore how the team is positioning the Fidelity Extra Income Fund so that it can continue its 20-year run of providing an attractive income across a range of different economic and political environments. The managers of the Fidelity MoneyBuilder Income portfolio explain why they are feeling increasingly positive on the outlook for sterling investment grade credit in 2020, and discuss the benefits of investing across the maturity spectrum in the Fidelity Short Dated Corporate Bond Fund following its three-year anniversary in 2019.

This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. The ideas and conclusions here do not necessarily reflect the views of Fidelity’s portfolio managers and are for general interest only. The value of investments and the income from them can go down as well as up and clients may get back less than they invest. Past performance is not a reliable indicator of future returns. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuer’s ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between different government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the Fund investing in them. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investments in Fidelity funds should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0120/23529b/SSO/NA

Important Information

The managers also highlight the resources at their disposal; from a team of unconstrained research analysts, insights from the equity team, and the group’s trading desks, all of which contribute to a global coverage model with unrivalled insight.

Campe Goodman on how impact bond investors can shift the world into a better trajectory

Focus is a publication that brings you face to face with a selection of the most in-demand asset managers in the UK and across the globe.

CAPITAL: All investors should consider the risks that may impact their capital, before investing. The value of your investment may become worth more or less than at the time of the original investment. The Fund may experience high volatility from time to time. CONCENTRATION: Concentration of investments within securities, sectors or industries, or geographical regions may impact performance. CREDIT: The value of a bond may decline, or the issuer/guarantor may fail to meet payment obligations. Typically, lower-rated bonds carry a greater degree of credit risk than higher-rated bonds. CURRENCY: The value of the Fund may be affected by changes in currency exchange rates. Unhedged currency risk may subject the Fund to significant volatility. INTEREST RATES: The value of bonds tends to decline as interest rates rise. The change in value is greater for longer term than shorter term bonds. BELOW INVESTMENT-GRADE: Lower rated or unrated securities may have a significantly greater risk of default than investment grade securities, can be more volatile, less liquid, and involve higher transaction costs. EMERGING MARKETS: Emerging markets may be subject to custodial and political risks, and volatility. Investment in foreign currency entails exchange risks.

Risks

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IN THIS EDITION

This material is for investment professionals only, and should not be relied upon by private investors.

FIDELITY MONEYBUILDER INCOME & SHORT DATED CORPORATE BOND

Balancing risk and return

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Income across the credit spectrum

Sajiv Vaid: I’d say we are cautiously optimistic for 2020. When looking at aggregate valuations, it is hard to see a repeat of 2019-type returns. However, the ostracism of sterling investment grade (IG) credit has created value relative to US and euro investment grade. So from a global perspective, we certainly see potential for the UK to outperform its US and European counterparts.

UK corporate bonds had a decent 2019 despite an uncertain economic and political backdrop. What is the outlook from here?

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We are also positive on the real estate sector, particularly commercial and social housing property, as political clarity should allow market transactions to pick-up in this space. We also favour asset-backed securities as they offer stable cash flows, solid asset-backing and come with the robust covenants that are missing from straight corporate debt. Importantly, the downside protection they offer does not always mean that coupons are lower - more often than not issuers compensate creditors for the complex nature of some of the bond structures.

Kris Atkinson: The utilities space is a good example of an area we like. It still trades on wider spreads relative to peers but with nationalisation fears now firmly off the table following Labour’s election defeat, we expect some strong spread compression in the sector. While there are still some operational challenges, which we are monitoring, companies such as Thames Water have been trading significantly wider than the sector average but offer potential outperformance.

SV: Whilst we subscribe to the “lower for longer” thesis when it comes to interest rates, there is no doubt that as rates have moved lower, interest rate or duration risk has probably become more asymmetric in direction.

The flattening yield curve has meant shorter duration bonds are more in demand. How do you think about investing across the maturity spectrum?

The flattening of the yield curve in the UK means investors currently give up relatively little spread to move inwards on the maturity spectrum. In this environment, short-dated bonds look attractive as they allow investors to sweat their cash while taking a relatively small amount of credit and duration risk. We’ve seen growing interest in short-dated bond funds globally and for UK investors we launched the Fidelity Short Dated Corporate Bond Fund back in 2016 to meet this growing demand.

Ultimately, we would always point to the benefits that duration can provide should risk-markets turn and it is notable that a number of flags indicate we are moving ever closer to the end of the cycle. In this environment, longer duration bonds benefit from being lowly correlated to equities and also offer a higher level of income which is clearly attractive.

As political uncertainty recedes, credit fundamentals will now matter more to returns and we are approaching the coming months with greater conviction around making investment decisions based on credit fundamentals.

KA: Within the MoneyBuilder Income portfolio it makes sense to hold both long and short-dated bonds from a diversification perspective. We believe that investors are looking for three core attributes from their bond portfolios - income, low volatility and diversification away from equities – and that one can achieve this outcome using a mix of short and long-dated bonds.

Planetary priorities

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KA: The first point is we have a large and experienced team based in multiple offices around the world, so we operate a global coverage model. Our credit analysts also take sector coverage, irrespective of bond and issuer rating, allowing our analysts to look at credits up and down the spectrum giving them a broad view of their sector. We also combine these views with insights from our equity team, providing a much better and in-depth view of the companies we are analysing.

How does Fidelity’s unique team-based approach to researching ideas in this universe work?

As political uncertainty recedes, credit fundamentals will matter more to returns

Outside of credit analyst teams, we have a quantitative research and macroeconomic team that help in selecting the right opportunities and providing views on the broader market. For example, the quant team have produced a ‘nudge’ tool which highlights any oversold/overbought credits to our analyst team thus taking away some of the human bias inherent in investing.

SV: We also look to our trading desk for sourcing securities. On the one hand, they provide best execution and their experience allows them to find pockets of liquidity even in stressful periods. In addition they are our eyes and ears on the market. They are as much a part of the research process and provide genuine market insight, helping us analyse markets from both the top down and bottom-up. Together we identify the securities we believe are capable of generating additional income and capital appreciation relative to what we can achieve elsewhere.

Balancing risk and return in UK corporate credit

Past performance is not a guide to the future.

Fidelity MoneyBuilder Income Fund 12-month rolling returns

Fidelity MoneyBuilder Income Fund

Fidelity Short Dated Corporate Bond

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Fund launch

1995

Fund size

£3.3bn

Yield to maturity

Average credit rating

2.7%

A-

Fund details

UK Treasury 1.5% 2026

5.2%

Top five long exposures by issuer

Sajiv Vaid, Lead Manager, Kris Atkinson, Co-Manager

Sajiv joined Fidelity in 2015 as co-manager of the Fidelity MoneyBuilder Income and Extra Income Fund, becoming lead manager of both funds in January 2019. He joined from Royal London Asset Management where he managed the group’s flagship retail and institutional corporate funds. Kristian Atkinson manages the Fund alongside Sajiv.

Fidelity MoneyBuilder Income Fund

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Click on a fund name to view the information on that fund

Annualised volatility

3.4%

(fund)

3.6%

(index)

The Yield to Maturity (also known as the Redemption Yield) is the anticipated return on a bond / fund expressed as an annual rate based on price / market value as at date shown, coupon rate and time to maturity. The redemption yield is gross of any charges and tax. Annualised volatility is calculated using month-end data points and is the standard deviation of 36 monthly returns presented as an annualised number. Source: Fidelity International. As at 31 December 2019.

Électricité de France

Thames Water

THFC

HBOS

Absolute weight

2.6%

2.2%

1.7%

Fidelity MoneyBuilder Income Fund performance

Past performance is not a guide to the future.

Fidelity Short Dated Corporate Bond 12-month rolling returns

Fidelity Short Dated Corporate Bond performance since launch

Fund launch

2016

Fund size

£134m

Yield to maturity

Average credit rating

2.1%

BBB+

Annualised volatility

1.2%

(fund)

(index)

Fund details

General Electric

Absolute weight

Aviva

Co-Operative Bank

Arqiva Financing

2.5%

2.4%

2.0%

1.8%

Top five long exposures by issuer

Sajiv Vaid, Lead Manager, Kris Atkinson, Co-Manager

Kris has been a manager of the Fidelity MoneyBuilder Income and Fidelity Short Dated Corporate Bond Funds since January 2019. Kris was promoted to Portfolio Manager in 2011 with responsibility for managing global investment grade credit funds. Prior to that he was a senior analyst covering a variety of sectors across investment grade, high yield and emerging markets.

Sajiv Vaid (left), Lead Manager, and Kris Atkinson, Co-manager

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Source: Fidelity International, Morningstar, 31 December 2019. Total returns in GBP. Basis: bid-bid, income reinvested in GBP. The fund’s primary share class according to the IA is shown. Peers includes 8 funds in the IA Sterling Corporate Bond peer group that are Short-dated Corporate Bond funds with a track record through at least November 2016. Index: ICE BofA 1-5 Year Eurosterling Index.

Fidelity Extra Income

Peter Khan, Co-Manager, Fidelity

Stan Verhoeven From 2007 to 2011, Stan worked at Kempen & Co as a quantitative analyst and (exotic) derivatives trader. He joined RBS in London in 2011 and moved to PGGM in 2012, where he was responsible for research into alternative risk premia. In 2015, he joined the Factor Investing team at NN Investment Partners, where he develops and manages a broad range of rule-based strategies, in addition to being Lead Portfolio Manager of MAFO. He is a CFA charterholder and holds an MSc in Business Administration from Radboud University, Nijmegen.

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The fund is Fidelity Extra Income, one in a suite of core fixed income products in Fidelity’s diverse product range. The £617m fund celebrated its 20-year anniversary last year and today is managed by Sajiv Vaid and Peter Khan - two seasoned investors with over 50 years of experience in global fixed income markets.

Fidelity Extra Income began life as a response to sophisticated investor demand for a higher income version of the group’s highly successful Fidelity MoneyBuilder Income vehicle, allowing for slightly more credit risk. The aim of the portfolio is to deliver an attractive level of income, extracting the best value from investment grade and high yield bonds whilst not losing sight of the core attributes investors look for from their bond portfolios: an attractive level of income, low volatility and diversification away from equities.

Forward-thinking strategy

The result was a portfolio with a typical split of 60% investment grade credit and 40% high yield which could look across the credit spectrum in search of long-term risk-adjusted returns. This unique approach that the Extra Income Fund takes, investing across the credit spectrum, allows the team to take a more holistic view of credits. Vaid suggests the fund was ahead of its time in that it was really a prototype strategic bond fund before they became fashionable.

This fund was a prototype strategic bond vehicle – long before they were fashionable

to keep delivering the stable income investors want?

olitical and macroeconomic uncertainties continue to cloud the outlook for global financial markets. With growth anaemic and interest rates anchored at low levels, how are the managers of a sterling-focused fixed income fund positioned

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developed economies. Some challenges threaten the planet, others threaten people – three out of ten people in the world lack safely managed drinking water. (1)

he world faces diverse challenges from climate change and rising sea levels to the lack of affordable housing in

The risk-adjusted element is a crucial tenet of the Extra Income Fund, and the managers are explicit that this is not an ‘income at all costs’ fund. Whilst this is a credit focused strategy, the team also use duration at the margin to help to balance the risk in the fund.

“We don't always have an answer to the economic and political uncertainty facing the UK,” says Khan. “We are serving a Sterling-domiciled investor base so we can have confidence in holding high quality Sterling credits, but we remain selective. In line with investor expectations, Extra Income will tend to have more idiosyncratic Sterling risk than other portfolios so that is why it makes sense to offset some of that risk with duration exposure.”

We don't always have an answer to the economic and political uncertainty facing the UK

The hallmark of the fund since its inception has been its active approach in investing across the credit spectrum in order to deliver an attractive risk-adjusted income, rather than simply “yield at all costs”.

Alert to panic-sold value

In terms of current positioning, because of the late-cycle dynamics and company-specific risks, the managers say caution is merited. As such, they have moved up the quality scale in the belief that the stronger fundamentals of investment grade credit provide a more attractive risk-return profile.

Caution warranted?

This is underpinned by the team’s caution on energy, a sector that comprises a relatively large part of the high yield universe. “Energy spreads and equity prices have underperformed the price of oil itself. The drive to include more renewables in the mix and alignment with the rising ESG focus are likely to leave many of these assets permanently stranded. This theme also applies more broadly to resource sector names still configured for the previous commodity super-cycle”, Khan adds.

In this environment, a well-resourced credit research team is essential and having traders that can keep a check on markets is very helpful too, with this team approach serving the fund well over time.

While 2019 saw strong returns from fixed income - and corporate bonds in particular - few of the big picture uncertainties facing financial markets have been resolved. For Extra Income to keep delivering the risk-adjusted income investors demand over the next 20 years, it will require the team to remain nimble, leverage the strength of their research team, think a little differently about valuations and fully utilise the global opportunity set available when required.

Past performance is not a guide to the future.

Fidelity Extra Income Fund 12-month rolling returns

Fidelity Extra Income Fund performance

Fund launch

1999

Fund size

£617m

Yield to maturity

Average credit rating

3.9%

BBB-

Annualised volatility

2.9%

2.8%

(fund)

(index)

Fund details

Électricité de France

Absolute weight

HBOS

Virgin Money

Autostrade Per L'Italia

2.5%

2.3%

2.0%

1.7%

Top five long exposures by issuer

Sajiv Vaid, Lead Manager, Peter Khan, Co-Manager

Peter joined Fidelity as a trader in 2000 and was promoted to head of trading in 2003. He became a portfolio manager in 2009 and has run the Fidelity Global High Yield Fund since it was launched in 2012. He became co-manager of the Fidelity Extra Income Fund in January 2019, working alongside lead manager Sajiv Vaid.

Fidelity Extra Income Fund

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Income across the credit spectrum

Balancing risk and return

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Income from across the credit spectrum

FIDELITY MONEYBUILDER INCOME & SHORT DATED CORPORATE BOND

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Balancing risk and return in UK corporate credit

Balancing risk and return

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Income across the credit spectrum

A good example of this was an investment in bonds issued by Tesco. Around five years ago, Tesco was a key holding for the fund, and the team cut the position after a credit analyst raised concerns on weak business performance putting pressure on the company’s ability to retain its investment grade rating.

Tesco bonds were later downgraded to high yield and given the fund can invest across the credit spectrum, the downgrade meant the team were not forced sellers at potentially stressful prices. After the downgrade, the team topped up the holding seeing value once again and 2019 saw Fitch upgrade Tesco back to investment grade. As Khan explains, “being able to identify things other portfolios wouldn’t necessarily be able to take advantage of gives us a competitive edge, especially in the crossover space”.

Source: Fidelity International, Morningstar, 31 December 2019. Total returns in GBP. Basis: bid-bid, income reinvested in GBP. The fund’s primary share class according to the IA is shown. Peer group: IA £ Strategic Bond. Index: 60% ICE BofAML Euro-Sterling Index; 25% ICE BofAML Sterling High Yield Index; 15% ICE BofAML Euro High Yield Constrained Index Hedged to GBP.