Royal London Corporate Bond: March 2023 fund update

• Shalin Shah has over 14 years’ investment experience at Royal London
• The fund has delivered good returns over the long term and the managers benefit from the support of a strong fixed income team at Royal London
• The managers dig a little deeper to find bonds that might be missed by other investors
• This fund features on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Royal London Corporate Bond fund is focussed on investment grade bonds and aims to provide an income alongside some capital growth. We think it is a more adventurous choice in the space, with good long-term growth potential. As it can be more adventurous than some peers, the investment journey may be more volatile. For this reason, it could work well as part of a portfolio invested for income, focused on the long-term. It could also provide some bond exposure to a portfolio more focussed on company shares.

Manager

Following a change to the management team at the start of February 2023, the fund is co-managed by Shalin Shah and Matthew Franklin. Shah joined the fixed income team at Royal London in 2008 and has been involved in managing the fund since 2016. Franklin joined Royal London’s sterling credit team in 2014 and has co-managed the fund since January 2022.

Previous co-manager, and Head of Fixed Income at Royal London, Jonathan Platt has stepped back from his role as a named manager on this fund. He remains in his role as Head of Fixed Income though and so will continue to offer support and challenge to Shah and Franklin going forward. You can read our recent notification on this change here.

We rate Shah and the bond team at Royal London highly. They're prepared to invest in parts of the bond market a lot of other investors ignore. Looking for opportunities in under-researched areas like unrated bonds can throw up chances to boost returns, but it can also add risk. Both managers also have management responsibilities on other funds, but they’re supported by a very well-resourced team, so we feel comfortable they can handle the workload.

Process

Shah and Franklin believe credit markets are inefficient and offer opportunities that active managers can exploit. They start by forming a view on the direction of the economy, considering factors like economic growth, inflation and interest rates. This helps them decide which areas to invest in.

We think the team's edge comes from their detailed research into 'low-profile' parts of the market. Shah and Franklin feed off ideas from the wider fixed interest team but also do their own research to check if the quality of these bonds is high enough to be considered for the fund. These under-researched bonds may be unrated (their credit quality hasn’t been assessed by a credit ratings agency), complex and often secured against a company's assets. The managers can potentially add value by looking in this area of the market, but these types of bonds are higher risk, and the lack of credit rating can make them harder to trade, adding liquidity risk, particularly in a falling market. They tend to pay a higher income to compensate for the higher risk. Around 7.1% of the fund is currently invested in this area.

The fund has a focus on A and BBB rated bonds, which sit at the lower quality end of the investment grade corporate bond spectrum. The fund also invests in higher-risk high-yield bonds, which can add risk. The managers aim to be well diversified through exposure to a range of different sectors.

The managers have continued to look for opportunities in the new issues market – these are bonds newly issued by companies. Recent examples within banks and insurance include those of Investec, ABN Amro and Deutsche Bank. Outside of the financials sector, the team recently participated in an issue from Yorkshire Water too.

The managers expect the current higher levels of inflation we’re seeing in the UK to fall in the coming months, due to energy prices from 12 months ago falling out of the inflation calculations. They still think that UK interest rates are likely to continue to rise to help combat inflation further. The team also think that these higher interest rates will eventually lead to a recession in the UK.

Culture

We believe Royal London’s speciality is in managing fixed income portfolios. Their philosophy is that all well-diversified portfolios should include an element of income. They use a combination of top-down macroeconomic analysis and bottom-up security selection to manage their bond portfolios which has served them well over time.

The managers are rewarded based on the long term performance of their fund, so their interests are aligned with investors. We think their incentivisation structure is better than most and encourages good behaviour, but it isn’t as long term as in some other groups.

ESG Integration

The managers consider environmental, social and governance (ESG) factors in their analysis. This helps them identify potential risks that could affect the business’s ability to repay its debts, increase costs or result in future litigation.

All Royal London fund managers have access to ESG ratings and analysis produced by the firm’s central Responsible Investment team. The firm asks that all managers incorporate this into their investment decision making processes, but our meetings with Royal London fund managers suggest the quality of ESG integration from fund to fund is mixed. The firm’s sustainability branded funds fully integrate ESG, with the support of the Responsible Investment team.

The Responsible Investment team coordinates company engagement and engagement case studies can be found in the firm’s annual Stewardship and Responsible Investment report. The firm also publishes a summary of voting activity on its website, and an interface allows visitors to search for all voting activity relating to a specific company, or any time period, and includes a rationale in cases where the team voted against a proposal or abstained.

While this is not one of Royal London’s sustainability branded funds, we do think that ESG related risks are suitably considered as part of the bond selection process. That being said, the fund may still hold bonds that could be considered ESG sinners.

Cost

The fund has a standard annual ongoing charge of 0.56%, but we’ve secured a 0.19% saving for HL clients. That means a net ongoing charge of 0.37%. The HL platform fee of up to 0.45% per year also applies.

Charges can be taken from capital, which can increase the yield but reduces the potential for capital growth.

Performance

The fund’s more adventurous approach to investing in corporate bonds means it’s tended to be more volatile than others in the sector. Typically the fund has lost as much value as peers during market falls and outperformed them a little when markets rise. Over the long term the fund’s generally performed well for those investors who’ve been prepared to ride out the dips. Past performance is not a guide to the future.

The last year has been a difficult one for corporate bond investors. Interest rate rises, high inflation and a war on the ground in Europe have fed into bonds experiencing one of their worst years for performance in a generation. Over the 12 months to the end of February 2023 the fund has performed better than the IA £ Corporate bond peer group average though, returning -9.49% compared to -10.83%*. Our analysis suggests that this has been due to a combination of duration positioning and bond selection.

Duration is a measure of how sensitive the fund is to interest rate changes, the lower the duration value, the less sensitive the fund is to interest rate changes. The fund had lower sensitivity to interest rates in early 2022 when interest rates rose, which added value compared to many peers. At the end of February 2023, duration positioning was broadly in line with peers.

Bond selection has also added value over the year, with selections in banks, financial services and insurance adding the most value. Some bonds didn’t do as well though, such as those held within the consumer services sector. A year is a short timeframe to consider performance over and should be viewed in the context of a longer time period. Investors could get back less than they invest as the value of investments goes up and down.

At the end of February, the fund had a yield of 5.08%, although yields are variable, not guaranteed, and are not a reliable indicator of future income.

Past performance is not a guide to the future. Source: *Lipper IM to 28/02/2023.

Find out more about Royal London Corporate Bond fund including charges

Royal London Corporate Bond Key investor information