October can be a shaky month for markets in general, but when recent weeks have brought unsettling headlines, bearish thoughts can be stirred up.
Bankruptcies in the US of first Tricolor Holdings, followed soon after by First Brands, hit the news, triggering memories of the credit crunch of 18 years ago.
First Brands, a heavily leveraged auto parts manufacturer, reportedly resorted to pledging the same invoices multiple times to keep cash flowing before its downfall. Tricolor, a subprime auto lender, faced similar allegations, raising serious questions about transparency in private credit structures.
As Jamie Dimon, CEO of JPMorgan, then warned: “If you see one cockroach, there are probably many more.” The initial knock-on effect was to hit US regional banks’ share prices, followed by a broader sell off into credit spreads.
Adding to the jitters, two US regional banks – Zions Bancorp and Western Alliance Bancorp – disclosed exposure to millions of dollars in bad loans and alleged fraud. While these were isolated incidents at banks with market caps under $10bn, the news drew natural comparisons to the regional banking stress that followed the collapse of SVB in March 2023.
Towards the end of October risk appetites returned, but in our view it’s a good time to take stock on bond exposures
However, both banks have since reported total provisions that were smaller than feared and delivered largely positive earnings, beating expectations and helping to calm fears of systemic risk.
Subsequently, other US regional banks started to report provisions that were smaller than market expectations, which further calmed things. Towards the end of October risk appetites returned, but in our view it’s a good time to take stock on bond exposures.
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Offsetting some of the wobbles is the fact that banking sector balance sheets are generally in good shape, and credit growth is positive, driven by large-bank lending.
However, delinquency rates are high on credit cards and auto loans in the US in particular, and the re-starting of student loan payments is a headwind to credit quality and credit growth. A flexible proven team suits these conditions, we believe.
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Our preference currently, and in fact for some time, has been to blend an anchor position in a sensible Global Strategic Bond fund managed with a risk-reward approach in that order – in our case, the in-house Nedgroup Investments team of David Roberts, Alex Ralph and Matt Cornwell.
For additional government bond exposures, we add an element of our own control of duration and currency via a mix of five iShares ETFs in Treasuries, Gilts and US TIPS. These positions are traded at the margin as market opportunities present themselves.
Currently, any direct credit risk we take is through investment-grade funds, which provides a level of insulation. This is supported by our chosen manager, PIMCO, which applies a consistent and unified investment process. Where we do hold high-yield exposure, it is limited to short-duration positions.
What this means is typically there are an average of 18 months to run until the bond issuer repays us, which leads to greater visibility on repayment potential and less exposure to interest rate risk as well. Lord Abbett is our preferred manager here, a privately held firm with a partnership structure and more than 50 years’ experience in high-yield investing.
Any direct credit risk we take is through investment-grade funds, which provides a level of insulation
We also invest in the Colchester Local Emerging Markets Debt Fund, which provides access to well-financed emerging markets without exposure to USD risk — a particularly valuable advantage this year. Colchester is an employee-owned boutique specialising exclusively in government bonds.
What else is out there to position for the future?
We are considering adding a mortgage-based fund to the portfolio but may wait for market noise to settle before making a move.
The fund would offer the advantage of a floating rate, and the manager we’re watching specialises in ‘seasoned’ loans — those issued before the global financial crisis, tested through that period and now with only a few years remaining. Historically, returns have been steady and robust.
So, when headlines about bond markets make you wonder who can still be trusted to pay interest and return your capital, remember that today’s bond fund universe offers a growing range of specialised options.
With the right selection, you can find a bond as resilient as 007 — and sidestep the double agents.
Rob Burdett is head of multi-manager at Nedgroup Investments
