Here at Royal London Asset Management, we put significant focus within our investment process on finding inefficiencies, on seeking out extra return for our clients, and nowhere is that more evident than in our Royal London Sterling Extra Yield Bond Fund. This fund has a simple edict: find undervalued debt.
The fund, run by Senior Fund Manager Eric Holt, has recorded stellar performance since its inception* – ranking among the best funds in either investment grade, high yield, or strategic bond. This performance stems from the four ‘pillars’ of the fund: valuing the attractions of secured bonds, having no specific benchmark, flexibility to invest in investment grade, high yield and unrated bonds, and seeking adequate liquidity within the fund.
We asked Eric about the fund, how he does things, and its future.
Why go for a no benchmark fund?
The opportunity set in fixed income is massive and there are clear inefficiencies. Sterling Extra Yield was devised to go anywhere – and this is what sets it apart.
Our ‘go anywhere’ mentality predated the unconstrained strategies that have developed in recent years and was based upon the view that bond markets offer the active manager significant scope to add value. I feel that having the ability to combine investment grade, high yield and non-rated bonds is the best way of achieving strong long-term returns.
When we launched the fund, we decided to forego an index benchmark and instead offer a yield advantage over UK government bonds. So I was not beholden to align the fund to the characteristics of any specific benchmark, instead we could invest in the securities we most favoured.
Not being implicitly constrained by a benchmark offers the fund much greater flexibility – which has always been a major positive. This flexibility is reflected in the fund’s A shares offering a gross redemption yield at the end of August 2023 of over 8.9%.
As a result, the fund has delivered significant outperformance versus benchmarks and peers across strategic bond, investment grade and high yield funds.
To the end of August 2023, the fund’s A class is ahead of peers over 12 months, 3 years, 5 years, 10 years, 15 years, and 20 years. It should be noted, however, some of the longer-term outperformance stems from survivorship bias – as not many funds have lasted that long – but this is a testament to our staying power and consistent, repeatable investment process.
Since inception, in April 2003, the fund’s A class has returned nearly 6.7% per annum to investors, with the next nearest fund returning below 5.5%. Over 20 years, our 6.7 annualised return is more than double the Corporate Bond peer sector average and more than 1.2% ahead of the High Yield sector average. Over 10 years, its 5.5% annualised return is 1.9% ahead of its nearest competitor in the strategic bond peer group.
This remarkable, consistent outperformance has only been possible owing to our investment strategy and patience – giving us the ability to seek out market inefficiencies which deliver incremental returns over the medium term.
How do you manage this fund when the scope is so broad?
Building this performance might seem daunting, but it is important to remember that this isn’t just me: I work within a very experienced, collegiate, stable and focused team. I’ve worked with Jonathan Platt since 2000 and with Head of Sterling Credit, Paola Binns, for almost the entire life of the fund. Relationships developed over these many years ensure nothing is ever left to chance and no one is comfortable resting on their laurels, either. Financial markets are a source of continual challenge, and opportunity.
This is never more evident during market downturns, seen in 2008 during the Great Financial Crisis (GFC) or during the turbulence seen in the early parts of the Covid period. These events show the fund remains influenced by market events, but the key driver of performance has been the team’s investment philosophy – focused in a higher performance fund.
This can be seen across the range of securities the fund holds. We ended May 2023 with over 200 holdings, not beholden to geography or industry: ranging from offshore wind turbine servicing companies, through UK building societies, to infrastructure finance and a state power company in Sweden.
In the past, we have taken advantage of cyclical lows to invest in secured bonds in the shipping industry, purchased Tesco secured bonds when their credit rating slipped into sub-investment grade, and bought social housing bonds at a very subdued level disconnected from their long-term creditworthiness. We are open to different sectors, industries, and companies: once again, our flexibility is key.
The social housing investment referenced above highlights our investment process; late in 2022, S&P downgraded Swan Housing Association – a medium sized social housing provider in east London and Essex – from BBB to BB-, taking the issuer to sub-investment grade. The downgrade followed a deterioration in Swan’s financial profile as a result of delays and cost inflation in its acclaimed development programme. Its proposed merger with Orbit Group, a larger social housing operator, did not take place and the bonds were downgraded, despite a replacement partner, Sanctuary Housing Association – a much larger national operator – already having been identified. Given our flexibility to purchase sub-investment grade bonds, we were able to buy Swan bonds at attractive levels from forced index sellers. On completion of the merger with Sanctuary the bonds were upgraded back to BBB triggering a sharp uptick in value and enabling the fund to crystallise a 35% profit within five months of making its investment.
We have built on Sterling Extra Yield’s success through Global Bond Opportunities, a fund that follows a similar approach but with no sterling bond constraint – the Sterling Extra Yield fund has a minimum of 75% in sterling denominated assets. I work with Rachid Semaoune together as co-managers on both funds.
What role can the team’s focus on security have for a fund like this?
The fund is a shining beacon of our focus on secured credit investment. By being prepared to invest in non-rated bonds the fund has tapped into an under-researched and less efficient market of the global credit market.
In the broadest of terms, secured credit represents a welcomingly diverse set of economic exposures with one critical commonality – a charge over assets and/or cash flows. Security is a key credit enhancement, providing tangible backing to enhance bond recovery should a company default. However, its true value is more nuanced. By investing in bonds with the right type of security, both in terms of legal enforceability and appropriateness of collateral, dovetailing with protective covenants, such as early triggers that require issuers to supplement collateral pools as values fall, we can inject more dynamic protection and interaction into our credit portfolios.
Secured lending has always been at the heart of our differentiated credit approach and the more the wider market commoditises bond investment, the more our experienced team are motivated to research the details of corporate bonds that can make a fundamental difference to portfolio risk and return.
Does a fund like this have a place if global bond yields have rebounded from the historic lows of the last 10 years or so?
As passive strategies gain ground the advantages of our investment philosophy, which reaches its most intense form in Sterling Extra Yield and Global Bond Opportunities, become more apparent. These funds offer a clearly differentiated approach and over 20 years, Sterling Extra Yield has demonstrated how this can work to the benefit of our clients.
Markets remain fascinating and navigating the balance of risk and return remains the same as it was 20 years ago, but now we feel you are well paid for yield risk. When gilts were yielding near-zero, you had to hunt for value. Now we see attractive yields in lower-risk assets, including an increasingly wider range of investment grade corporate bonds. A recent issue from Spanish lender Santander is a prime example of this: issuing five-year senior bonds with a yield just under 7.5%. This broader opportunity, however, still reflects a balance of risk and return – the prevailing higher yield environment will bring with it economic challenges and we will need to manage investments well within that environment.
Why keep doing it?
I wouldn’t be here if I wasn’t enjoying it. I continue to see opportunities and believe the fund can perform well for investors.
As we see markets shifting and adjusting to a post-Covid, post easy money world, it is as important as ever to make sure the fund is positioned to take advantage of market inefficiencies. We see challenges ahead, but these challenges allow us to differentiate ourselves.
The biggest hurdles ahead are the well-described economic troubles lurking on the horizon – in particular when inflation pressures recede, when the Bank of England decides enough is enough and begins to cut rates, and as we still wait for past interest rates rises to work through into the UK and global economies.
In this environment we believe the attractions of a diversified, flexible, uncontained portfolio are particularly attractive and we look forward to maintaining the long track record of outperformance and strong income generation.
*The RL Sterling Extra Yield Bond Fund A Inc has generated an annualised return of 6.65% since inception (net of fees, mid-price to mid-price, as at 31 August 2023.)
This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.
Counterparty risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the fund to financial loss.
Credit risk: Should the issuer of a fixed income security become unable to make income or capital payments, or their rating is downgraded, the value of that investment will fall. Fixed income securities that have a lower credit rating can pay a higher level of income and have an increased risk of default.
Efficient Portfolio Management (EPM) techniques: The fund may engage in EPM techniques including holdings of derivative instruments. Whilst intended to reduce risk, the use of these instruments may expose the fund to increased price volatility.
Exchange rate risk: Changes in currency exchange rates may affect the value of your investment.
Interest rate risk: Fixed interest securities are particularly affected by trends in interest rates and inflation. If interest rates go up, the value of capital may fall, and vice versa. Inflation will also decrease the real value of capital.
Liquidity risk: In difficult market conditions the value of certain fund investments may be difficult to value and harder to sell, or sell at a fair price, resulting in unpredictable falls in the value of your holding.
The Fund is a sub-fund of Royal London Asset Management Funds plc, an open-ended investment company with variable capital (ICVC), with segregated liability between sub-funds. Incorporated with limited liability under the laws of Ireland and authorised by the Central Bank of Ireland as a UCITS Fund. It is a recognised scheme under the Financial Services and Markets Act 2000. The Management Company is FundRock Management Company SA, Registered office: 33 rue de Gasperich, L – 5826 Hesperange, Luxembourg and is authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF). The Investment Manager is Royal London Asset Management Limited. For more information on the Fund or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.com. Most of the protections provided by the UK regulatory system, and the compensation under the Financial Services Compensation Scheme, will not be available.