Invesco: Monthly Income Plus (UK) – positioned to take advantage of recovering markets

While investors will of course be disappointed to have seen the value of their investment fall, having bounced back from the low point seen on 19 March, the fund NAV is now at levels seen in the final quarter of 2019.

On top of this, there is now considerably more value, opportunity and income available to us than there was at year-end.

We have always sought to position the fund to produce income while at the same time seeking to protect investors when markets were expensive and add risk during periods in which the balance of risk and reward were attractive.

This approach has served the fund well as can be seen in the chart below showing performance since launch in 1999. Similar periods to this, such as 2008-9 and 2011 saw the fund adding risk during a period of market dislocation. In both previous cases this benefitted investors as markets started to recover, going on to deliver strong returns

Given the low level of yields and the tightness of credit spreads, the fund started the year with plenty of ‘liquidity’ – almost 20% cash, sub one-year bonds and US Treasuries.

Within the ‘credit risk’ component of the fund, again given the limited value on offer, the exposure to high yield was of a relatively high quality. We further reduced high yield exposure through hedging.

It was a similar picture in financials, where the decline in yield was justified by underlying improving fundamentals and supportive monetary policy. But, with yields on the most junior form of bank security, AT1s (CoCos) falling to a low of just 5% according to the ICE BoA CoCo Index, we believed that a more defensive stance was warranted and had reduced exposure.

The fund also invests in UK equities, managed by Ciaran Mallon. Given the limited value and the ongoing concern around Brexit, last year we cut the equity allocation from 14% at the end of January 2019 to just 8% by the end of the year.

As the chart above shows, as a result of the combination of governments’ measures to stem the spread of Covid-19 and the collapse of the OPEC+1 negotiations, investment grade credit spreads in February and March widened from 122bps to 288bps within the space of a month. In aggregate this has put spreads back at levels last seen during the Eurozone crisis, but they have not reached the levels seen during the Global Financial crisis. In high yield the moves have been even larger, with spreads widening from 429bps to 1039bps.

Although they remain elevated, spreads have tightened to 219bps and 887bps. It is important to put this in context. Spreads remain at their widest level since 2011/12.

Subordinated bank debt has also seen some extreme moves with some bonds falling as much as 50 points – a recently issued bond from Unicredit fell to a low of 53. While the 2008 crisis was centred on the banking system, this time the problem lies with the broader economy. Banks will suffer in terms of earnings, but their balance sheets are much stronger than they were previously.

Fund activity over the past six weeks has seen us begin to add in areas of the bond market that offer very attractive yields. But we are not in a rush. In high yield we have added in small size to bonds we know well at prices from the mid-50s up into the 90s. We also added a couple of better-quality oil majors. In financials we added to senior bank debt, legacy tier 2 and CoCos. Cocos were added at prices ranging from mid-50s to mid-90s as well. But it is in investment grade where most of the activity has been so far. With central banks in the market buying bonds, companies have rushed to issue debt, in many cases at very attractive yields.

Within equities, Ciaran believes that strong companies will get to the other side of this crisis and will regain much of the earnings they are losing now. He is seeing companies in a number of sectors that look attractive on a longer-term view. We think equities are likely to be an attractive option for us at some point, but right now we are focused on the value we are finding in bond markets.

Although we did not foresee the circumstances of this crisis, we had already reacted to the limited value we saw in large parts of our markets. We are not looking to add significant risk now, but we have been adding slowly and steadily. But it is important to look ahead. This is a fund that aims to deliver income. Right now, the likelihood is that government bonds will deliver less of that than ever. UK Gilts currently yield less than 0.5%. On the other hand, credit spreads are wider than at any time since 2011/12, in investment grade as well as high yield.

With the market falls and additions that we have made to the fund we have really started baking some value in for when markets recover. In the meantime, the yield is very compelling.

Based on data for the Z Acc share class, the underlying yield has increased from 3.92% at the end of January to 5.11% at the end of March. The distribution yield has increased from 4.64% to 5.83%.

At the same time, based on our own unofficial pre fees data, the average price of bonds has gone from 105.24 to 91.16 over the same period. Even after the recovery of the past couple of weeks it was 95.70 as at 17 April.

The fund has a high yield once again and the prospect for some capital appreciation from these levels.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.

The securities that the fund invests in may not always make interest and other payments nor is the solvency of the issuers guaranteed. Market conditions, such as a decrease in market liquidity for the securities in which the fund invests, may mean that the fund may not be able to sell those securities at their true value.

These risks increase where the fund invests in high yield or lower credit quality bonds and where we use derivatives.

The fund has the ability to make use of financial derivatives (complex instruments) which may result in the fund being leveraged and can result in large fluctuations in the value of the fund. Leverage on certain types of transactions including derivatives may impair the fund’s liquidity, cause it to liquidate positions at unfavourable times or otherwise cause the fund not to achieve its intended objective. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested resulting in the fund being exposed to a greater loss than the initial investment.

The fund may be exposed to counterparty risk should an entity with which the fund does business become insolvent resulting in financial loss.

The fund may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events. As one of the key objectives of the fund is to provide income, the ongoing charge is taken from capital rather than income. This can erode and reduce the potential for capital growth.

Changes in interest rates will result in fluctuations in the value of the fund.

Important information

All data is as at 31 March 2020, sourced from Invesco unless otherwise stated.

Benchmark: Investment Association Sterling Strategic Bond Sector. This is a comparator benchmark. Given its asset allocation the Fund’s performance can be compared against the Benchmark. However, the Fund is actively managed and is not constrained by any benchmark.

Many funds sold in the UK are grouped into sectors by the Investment Association (the trade body that represents UK investment managers), to facilitate comparison between funds with broadly similar characteristics.

Please note the FTSE All share Index is not a target, constraining or comparator benchmark of the fund. The comparative information shown here is to illustrate the fund manager’s active investment approach and provide broader market context.

Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.

This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.

For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the Annual or Interim Reports and the Prospectus, which are available using the contact details shown.