This is a non-independent marketing communication commissioned by Invesco. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
The hunt for yield has been a major headache for investors over the past decade. A lengthy period of ultra-low interest rates has meant the so-called ‘risk-free’ component of most portfolios, developed market government bonds like US treasuries, produced returns that barely matched inflation, if at all.
For many investors the result was a move up the risk scale into equities. If bonds couldn’t cut it, then they’d have to get their income from company shares instead. The problem with this approach is that many of the big dividend payers performed poorly too. Whereas lots of high-growth firms that often paid no dividends appreciated massively in value, many high yield stocks did the opposite.
Frustrating though this may be, it’s easy to forget that the investment universe is broader than government debt and company equities. For instance, alternative assets, like energy investments, have become one way for yield hunters to generate income for themselves.
Another option is the market for high yield bonds. Often overlooked by investors, debt securities beyond low-yield government bonds can offer the potential for the sort of yield that dividend seekers are after.
The small caps of the fixed-income world
It’s also an area that arguably attracts more opportunity for active managers. Like the small cap sector, high yield bonds tend to receive less analyst coverage, meaning there is arguably more opportunity to take advantage of mispricing in the market.
Invesco Bond Income Plus (BIPS) is one investment trust that focuses on the sector. Managed by Rhys Davies and deputy portfolio manager Edward Craven, BIPS was formed last year through the merger of Invesco Enhanced Income and City Merchants High Yield.
The trust is well-equipped to take on the market, with Invesco’s 19-strong fixed interest team of fund managers and analysts contributing to the investment process. Invesco also has five fixed income dealers at their disposal. This may not sound important but pricing is much more opaque in the high-yield bond market compared to equities. Having a trading team that can get the best pricing is thus a major asset.
A collaborative approach
But before any trades are placed, the Invesco team go through a rigorous investment process. Davies and his team will look at the existing macroeconomic factors and environment, using it to put together a framework under which investment decisions can be made.
A 10-strong team of credit analysts also do the hard work of sorting the good from the bad in the bond markets. Third-party research may play some role in this, but the team will also undertake their own in-house efforts to try and evaluate which bonds are worth buying.
A collaborative effort is then made to put together the trust’s portfolio. The fund managers, who themselves are highly experienced in credit analysis, will speak with the analyst team to determine how BIPS should be investing.
This is not a top-down process but an open one, in which the analysts and fund managers can discuss ideas on a level playing field and try to work out what the best options on the table are. Once risk management factors are taken into account, the dealing team will then get to work.
Not what you’d expect
What the portfolio ends up looking like may come as something of a surprise to investors that may feel uncomfortable investing in high yield bonds. For some, the phrase seems to conjure up defaulting governments and vanishing investments.
The reality is slightly different. Most of the BIPS portfolio – about 70% - is in debt belonging to well-established, high quality businesses that tend to be more leveraged than others.
Companies like Virgin Media, Ford, Asda, and Thames Water all feature in the investment trust’s portfolio. Defaults can obviously never be ruled out but these are hardly desperate businesses on the brink of collapse.
Aside from these bonds, about 20% of the investment trust’s portfolio is in subordinated debt in banks and insurers, including contingent convertible bonds (‘CoCos’). Again, the risks should not be ignored here. Subordinated debt does mean bondholders are further down the pecking order in the event of a default and CoCos carry some distinctive risks that have to be understood as part of the investment process.
At the same time, the issuers include the likes of Barclays, Natwest, and UBS, all well-respected banking franchises that are required to meet high standards of corporate practice.
The final portion of the BIPS portfolio is slightly different. Here the trust managers look for bonds that have come under price pressure due to fears about fundamental weakness. If the managers believe a turnaround is possible then they’ll look to buy but only if there is the right mix of risk and a high potential upside.
A strong yield
Combining all these different approaches to the market typically leaves BIPS with a well-diversified portfolio. At the time of writing the trust holds approximately 250 securities that were issued by 188 different companies.
Doing so has enabled the trust to aim at paying an 11p dividend from last year’s merger up until 2024. That is not a guarantee, but City Merchants had a long history of consistent dividend payment and so far BIPS has met the dividend pay outs needed to meet that target.
Given the current share price, that equates to a yield of just under 6%. Perhaps investors don’t need to stress so much about finding income after all.
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