05 Apr 2021
Jonathan Platt, Head of Fixed Income
It sounded funny at first – a massive container ship stuck in the Suez Canal. The pictures were amazing, showing both the predicament and indeed the sheer size of modern cargo vessels. The reality though is that billions of dollars in trade was halted, shipping rates have soared, and oil prices have firmed.
The numbers are large: the canal handles around 12% of seaborne trade and each day of blockage disrupts more than $9 billion worth of goods. The Suez Canal truly was one of the great achievements of the nineteenth century, and courtesy of the foresight of the initial investors, thirty days’ sailing time is saved.
Historically, infrastructure projects were generally ‘private’ with the role of governments being relatively small. Today’s big investments in infrastructure tend to be led or dependent upon state support. This means that investment access to these projects can be quite limited; only in recent years have we seen the growth of infrastructure equity funds and changing investment appetite by the large global pension schemes.
From a fixed income perspective our investors look for stable cashflows; early stage infrastructure investment with its higher risk is primarily the domain of equity. However, when looking at the scale of our credit funds’ underlying investment in infrastructure debt – at the safer end of this spectrum – it is striking in both its scale and variety. Within our sustainable credit strategies, we invest in issuers that can demonstrate a net benefit to society as a well as ESG leadership. This results in significant exposures to what could be termed infrastructure in its broadest form: social and affordable housing, schools and universities, companies helping to transition to a lower carbon economy, road and rail infrastructure, hospitals and general healthcare, and utilities.
However, it is not just in sustainable investing that we favour infrastructure debt. Throughout our sterling credit range, taken to its greatest extent in our diversified asset backed strategy, we favour secured debt. We see asset backed debt as much wider than the narrower definitions used around Asset Backed Securities (ABS) – which tend to focus on residential or commercial mortgage debt, auto and credit card loans. For us, secured debt covers a wide universe and infrastructure debt often fits the bill nicely and is one of the reasons that our sterling funds, across our full spectrum, have high weightings in this area.
Cash rates were broadly unchanged over the week; sterling declined against the US dollar and gained against the euro.
The UK services Purchasing Managers’ Index (PMI) jumped to 56.8 from 49.5, a 7-month high, partly driven by a surge in residential property transactions. Manufacturing hit 57.9, a 40-month high, and business optimism also picked up. In the euro area services PMI improved, but remained below 50.0, and business optimism fell slightly. In both regions there were indications of stronger price pressure; In the UK the output price PMI reached its highest level for three years.
The US composite PMI declined slightly to 59.1 in March after 59.5 in February but is still well above the 50.0 ‘no growth’ level. The deterioration was driven by manufacturing output where supply shortages constrained growth. However, manufacturing new orders indicator reached their highest levels since June 2014 and composite employment and business optimism PMIs improved, driven by the vaccine roll out, reopening hopes and fiscal stimulus.
10-year US government bond yields moved lower to 1.64% with longer dated yields falling a bit more. In the euro area, yields also declined with Italy reversing recent weakness – a move mirrored in the UK where 10- and 30-year yields fell by 8 bps. Global real yields broadly moved in step with nominal yields although there was some increase in implied inflation at the long end of the US market.
Sterling credit spreads were broadly unchanged, and issuance was lower than in the previous week. We bought into a new issue from Southern Water which looked good value for a medium-dated utility bond at a spread over gilts of 1.25%.
Spreads remain at the tighter end of my expected range, but pockets of value can be found – particularly in ABS and collateralised bonds. Despite the challenges in the property sector, we added to British Land secured debt in some funds – and I still find it amazing that the secured debt trades at a higher yield than unsecured debt of similar maturity.
Coming to the end of the quarter sterling credit has had a relatively low-key period although greater challenges await as economies adjust to lower government support.
In the euro area, issuance continued to keep investors busy – about €13bn in the week and €42bn on the month. This has led to some indigestion, with spreads drifting a bit wider and many recent deals have traded poorly. There was a similar theme in the US market where supply remained heavy – the feature of the week being issuance from Oracle. Elsewhere the Turkish lira dived on a change to the Central Bank’s governor, although the impact on credit markets was considerably more muted.
In high yield, spreads widened marginally. We participated in several new issues including Alta Equipment, an industrial and construction equipment company, and Seplat Petroleum, an oil and gas exploration company operating in Africa.
Globally, I expect more infrastructure spending by governments. I think this is recognised in the US as a requirement, but others may see the need for domestic investment to support a more ‘self-sufficient’ approach in a post pandemic world. This should give rise to a greater variety of investment opportunities for bond investors and will increase the composition divergence between equity and bond indices. Good for active managers, I think.
Past performance is not a reliable indicator of future results. 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 originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.