April 21, 2013 5:17 am

Kames quits European periphery

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Kames Capital’s Phil Milburn is selling down the remainder of his peripheral European holdings in his £1.4bn High Yield Bond fund on concerns that the market has not fully priced in risks in continental Europe.

Mr Milburn, who co-manages the fund with Melanie Mitchell, says he was surprised how little reaction there had been to the election in Italy and the Cyprus bank levy.

The fund has been defensively positioned since the second half of 2012, but the managers have been taking even more money out of Italy in recent weeks and selling the lower quality parts of their only Irish holding, Ardagh.

Mr Milburn says: “We have looked at our peripheral Europe holdings and in the past couple of weeks we have been reducing our exposure to Italy.

“It had rallied a lot and I think the market underreacted to the problems in Cyprus.”

The manager said while it was true that the situation in Cyprus, with its uniquely large proportion of largely foreign-owned bank deposits compared with gross domestic product, was a one-off in many respects, “it has some points that can be extrapolated to the rest of peripheral Europe”.

Mr Milburn adds that he is “surprised there was not any reaction in peripheral Europe to the Cyprus situation”.

“If there was the smallest of whiffs of contagion then you would imagine there would be queues forming up across peripheral Europe.”

In addition to his bearish stance on peripheral Europe, Mr Milburn also believes that the markets seem to be overly optimistic about the prospects for the US.

“The US has good momentum, but it might not have as much momentum as people think,” he says.

“The sequestration cuts will have a negative impact, particularly on consumption, which accounts for roughly 60 per cent of GDP.”

In spite of his worries about the headwinds for the economy, Mr Milburn says he is still happy with having half of his fund denominated in dollars, and recently made a significant dollar addition to the portfolio.

The fund has built up a large position in Heinz, the US food group, after its leveraged buyout by Warren Buffett’s group, Berkshire Hathaway, and 3G Capital.

Part of the funding for the deal involved a $3.1bn bond issue with a coupon of 4.25 per cent.

Mr Milburn says the yield was so low because of a high level of oversubscription, but he was happy participating in the issue because he thought the medium-term prospects of the group’s credit returning to investment grade were very strong.

The position in Heinz is now the fifth-largest holding in the High Yield Bond fund, which also recently built up a 1 per cent position in McGraw-Hill Global Education, a bond issued to finance the leveraged buyout of the educational publishing segment of McGraw-Hill.

The coupon on the bond was 9.75 per cent but Mr Milburn says he thought the strengths and “solid free cash flow generation” of the business made up for the risks it faced transferring from print to digital content.

Matthew Jeynes is a senior reporter at Investment Adviser

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