FUND MANAGER COMMENTARY ROYAL LONDON STERLING CREDIT FUND MAY 2016 Paola Binns SENIOR FUND MANAGER For professional investors only, not suitable for retail investors 1 P A G E
PERFORMANCE & FUND REVIEW ASSET MANAGEMENT The Fund recorded a net return of 0.78%, versus a 0.78% net return for its sector (IA Sterling Corporate Bond). The Fund s bias towards credit, with a significant underweight in supranational debt, was positive over the month as supranationals underperformed. Overweight allocations to insurance and subordinated financials also made positive contributions to performance. Duration positioning was slightly below benchmark and was a small negative factor in relative performance, as gilt yields fell. Consumer services sectors performed well over the month, and the Fund s underweight allocations here were therefore disadvantageous. There was no material change in sector positioning; underweight exposure to supranational bonds and a bias towards secured and structured bonds remained the most noticeable features. The Fund participated in two new issues: a 350m issue of senior unsecured notes maturing in 2023 by betting firm William Hill, and an A-rated secured issue by student accommodation manager Unite USAF. The Fund also took the opportunity to increase its exposure to a number of illiquid issues in the housing sector, including Places for People Homes, Home Group and Housing Finance Corp. Elsewhere in secondary markets, the Fund added to a range of holdings, including Greene King Finance and Equity Release. ECONOMIC DEVELOPMENTS Market sentiment remained cautious against a backdrop of uncertainties ahead of the UK Brexit referendum and concerns over the extent and effectiveness of loose monetary policy. Supported by encouraging data, the US Federal Reserve (Fed) exhibited increasing confidence in the possibility of implementing a further interest- rate rise in July. The UK was overshadowed by first-quarter data that demonstrated a significant slowdown, particularly in manufacturing and services, which was broadly attributed to business hesitation prior to the June Brexit vote. MARKET HIGHLIGHTS Benchmark 10-year gilt yields fell slightly as investors nudged back towards safe havens in the run-up to the Brexit referendum in June, with gilts posting an asset class return of 1.75% (FTSE gilt index). Sterling investment grade corporate bonds underperformed their government counterparts, with a return of 1.24% (iboxx credit index). Credit spreads (the yield premium over gilt yields) moved within a narrow range, ending the month 0.03% wider. Absolute returns across credit sectors were positive, with little dispersion, but were generally lower than in April. Secured and structured bonds, and real estate in particular, spearheaded performance, rebounding after a couple of subdued months. Less market-sensitive areas such as transport and healthcare fared well in a muted risk environment. Financials outperformed, and insurance continued to make up lost ground from the beginning of the year, supported by the European Central Bank s (ECB) purchase programme. At the other end of the spectrum, the energy sector lagged despite a moderate increase in commodity prices, and autos struggled as new emissions scandals came to light. Credit spreads widened across most sectors, with the notable exception being financials. Investment grade sterling corporate bond issuance declined again in May, reflecting caution ahead of the UK s June referendum on EU membership; issuance was dominated by the industrials sector. In equivalent euro markets, issuance increased compared to April, with the greatest volumes being in the financials and industrials sectors; overseas corporates continued to issue a significant amount of debt denominated in euros. 2 P A G E
MAY TOPIC: GREECE S GROUNDHOG DAY In the last week of May, yet another debt relief agreement for Greece was reached by eurozone finance ministers, unlocking 10.3bn in Funds and potentially paving the way for the International Monetary Fund to join the bail-out by the end of the year. This latest agreement made progress in terms of forging a sustainable, long-term pathway out of the country s vicious circle of austerity and recession, and acknowledged what has already been achieved through strict austerity policies, but is a reminder that Greece will remain a source of political and financial tension for Europe and the eurozone for years to come. Investors must remain aware of the potential for exaggerated reactions in markets which have proven sensitive to news, and the potential for the perceived economic troubles of one country to quickly spill over into others in such an environment. Portfolios should be able not only to weather short term volatility, but also to benefit from longer-term movements. For credit investors, portfolios should be built with safety and security in mind, while for government bond investors, the ability to be nimble around core positioning is key. COMPARIATIVE PERFORMANCE The chart above shows total return (net of fees and net of tax) of the Fund against the IA Sterling Corporate Bond sector. The IA sector contains a range of credit Funds with benchmarks reflecting <5year, All Maturities and >15 year, hence this may not be an accurate comparison of the Fund s duration and therefore performance. Information about past performance is not a guide to future performance. INVESTMENT OUTLOOK We expect the current global expansion will be sustained through 2016, supported by loose monetary policy, historically low bond yields and the low oil price. Medium-term economic conditions, however, will remain challenging as deleveraging continues to be a dominant theme. In the UK, we expect inflation over the next 12 months to remain below the target level of 2%, and that wage growth will stabilise over the medium term. 3 P A G E
From their current level, which is below our assessment of fair value, we expect only a moderate increase in gilt yields over the next 12 months. Volatility seems likely to remain part of the economic landscape, with the EU referendum on the horizon. We believe that the present relative pricing of corporate bonds is still attractive over the medium term, while their level of income generation is also appealing with the prospect of short-term interest rates staying at historically low levels. Economic conditions in the UK seem likely to remain challenging and, in these circumstances, we believe bond characteristics which mitigate risk such as structural enhancements or a claim on assets or cash flows are especially important. 4 P A G E
CONTACT DETAILS Intermediaries Phil Reid Head Of Wholesale 020 7506 6775 Phil.Reid@rlam.co.uk Matt Jones Third Party Distribution Business Development Manager 020 7506 6739 Matt.Jones@rlam.co.uk Ian Furtado Business Development Manager 020 7506 6697 Ian.Furtado@rlam.co.uk David Billyard Business Development Manager 020 7506 6559 David.Billyard@rlam.co.uk Russell Evans Business Development Manager 01663 741 340 Russell.Evans@rlam.co.uk Institutional John Burke Head of Institutional 020 7506 6768 John.Burke@rlam.co.uk Alan Bunce Head of Institutional Business Development Direct Sales 020 7506 6570 Alan.Bunce@rlam.co.uk Kate Parker Institutional Business Development Manager 020 7015 2502 Kate.Parker@rlam.co.uk Emmanuel Archampong Institutional Business Development Manager - Insurance 07919 171 580 Emmanuel.Archampong@rlam.co.uk Philip Clifford Sales Director 07919 170 247 Philip.Clifford@rlam.co.uk Vathani Waran Consultant Relations Manager 0207 506 6558 Vathani.Waran@rlam.co.uk Chris Mills Consultant Relations Manager 020 7506 6655 Christopher.Mills@rlam.co.uk Business Development Support RLAM Business Development Support 020 7506 6754 BDSupport@rlam.co.uk This article is for professional customers only. The views expressed are the author s own and do not constitute investment advice. Information about past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount they originally invested. For funds that use derivatives, their use may be beneficial, however, they also involve specific risks. Derivatives may alter the economic exposure of a fund over time, causing it to deviate from the performance of the broader market. All rights in the FTSE gilt index (the Index ) vest in FTSE International Limited ( FTSE ). FTSE is a trade mark of the London Stock Exchange Group companies and is used by FTSE under licence. The Royal London Sterling Credit Fund (the "Fund") has been developed solely by Royal London Asset Management. The Index is calculated by FTSE or its agent. FTSE and its licensors are not connected to and do not sponsor, advise, recommend, endorse or promote the Fund and do not accept any liability whatsoever to any person arising out of (a) the use of, reliance on or any error in the Index or (b) investment in or operation of the Fund. FTSE makes no claim, prediction, warranty or representation either as to the results to be obtained from the Fund or the suitability of the Index for the purpose to which it is being put by Royal London Asset Management. Issued by Royal London Asset Management June 2016. Information correct at that date unless otherwise stated. Royal London Asset Management Limited, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, registered in England and Wales number 2372439. RLUM Limited, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority.All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number 99064. Registered Office: 55 Gracechurch Street, London, EC3V 0RL. The marketing brand also includes Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between sub-funds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259. Registered office: 70 Sir John Rogerson s Quay, Dublin 2, Ireland. Our reference: 804-PRO-06/2016-HC 5 P A G E