Peter Harvey, the manager of the F&C Sterling Corporate Bond Fund, spends plenty of time thinking about leveraged buy-outs.
He says one broker recently coined the phrase “LBO Idol”, an allusion to “Pop Idol”, the television show in which viewers vote for aspiring pop stars.
The broker said investors were casting their votes in the morning about which company would be the next to undergo a leveraged buy-out.
Bond prices tumbled recently at ISS, the Danish cleaning company, after two private equity groups launched a leveraged buy-out.
Prices also fell at other businesses as investors wondered who might be the next target.
Mr Harvey has pushed the fund underweight in consumer and industrial bonds because the companies lack covenants that might protect investors from any change of control, dispersal of assets or lack of disclosure.
“Don’t lend without covenants,” he says. “If the management is not ready to give that minimum commitment, keep your chequebook in your pocket.”
He is also cautious about investing in companies with exposure to consumers for wider economic reasons. In the UK, he is concerned about a slowdown related to the housing market, and in the US, he says: “They are up to their necks in debt.”
Covenants and concerns about household debt have led Mr Harvey to invest 12.5 per cent of the fund in consumer and industrial companies, compared with 15 per cent in the Merrill Lynch Sterling Non-Gilts index, the benchmark.
He says institutional investors dominate the fund, which aims to beat the index, “and we would have to have an extremely strong view to go to zero [in a sector]”.
The fund is also overweight in asset-backed securities, where Mr Harvey values the covenants and tangible nature of the assets.
Despite the heavy institutional ownership, F&C has recently brought in a retail share class, enabling private investors to hold the fund.
This move was in the UK corporate bond sector, a rare area to take in cash during March, when net retail sales – inflows into funds minus outflows – dropped by more than 50 per cent compared with the same month last year.
Mr Harvey has invested 40 per cent of the fund in financials, compared with the benchmark 33 per cent, and points to value in parts of the insurance sector.
The F&C manager also says UK insurers have improved their capitalisation ratios – the amount of equity they hold against liabilities. Mr Harvey cites equity issues by Legal & General and Prudential.
The latter angered some shareholders with an unexpected rights issue, but the news was good for bondholders such as F&CSterling Corporate Bond Fund: “As a lender, there’s a greater margin for error.”
On the outlook, Mr Harvey does not believe there is a significant risk of a “blow-out” similar to those of 1999 and 2001 because economic conditions are “pretty benign”.
He points to US economic growth of 3.1 per cent in the first quarter.
BBB rated bonds – at the lower end of the investment grade category – with 10-year maturities yield about 1.3 per cent more than comparable government debt. He says it is not the right moment to go overweight in lower rated bonds, and has invested 13 per cent of the fund in BBB, half the weighting which he had two years ago. “We are playing a cautious bat,” he says.
He has invested 27 per cent of the fund in “quasi-governments” – largely supranational entities and quangos with government guarantees.
“You hold them as a defensive part of your fund when the water is choppy,” the manager says.
Total expense ratio for institutional share class: 0.41%
Sector average: 0.53%
(Source: Fitzrovia International)
For more fund reviews see www.ft.com/fundfocus