Royal London Corporate Bond: April 2020 fund update

• The fund is managed by Jonathan Platt and Shalin Shah who have over 40 years combined experience
• The managers dig a little deeper to find opportunities that might be missed by others
• They invest quite differently to others in the corporate bond sector

How it fits in a portfolio

We think it's one of the best corporate bond funds available for those prepared to accept a little more volatility for what we see as excellent long-term potential. For this reason it could work well in a portfolio invested for income, focused on the long-term. The managers invest in some high-yield bonds too which could boost the income, but are riskier.

Manager

The fund is co-managed by the experienced duo Shalin Shah and Jonathan Platt. Shah has over 10 years’ experience working as part of the fixed income team. Platt is head of the fixed income team and joined the Royal London Group in 1985, has over 30 years of investment experience over which he’s been key to developing the fixed interest investment process. We rate the managers and the wider 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 that they can handle these other responsibilities.

Process

Platt and Shah 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, taking into account factors such as the direction of economic growth, inflation and interest rates. This then 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. 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. Platt and Shah do their own research to check if the quality of these bonds is high enough to be considered for the fund. 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.

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.

Platt and Shah expect the economic impact of the coronavirus to have a negative effect on corporate profitability. But they believe there are attractive rewards on offer for taking the risks of investing in corporate bonds. Some of these opportunities have been new issues including those of Wales & West Utilities and Volkswagen.

Culture

We believe Royal London’s speciality is in managing fixed security 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 also consider environmental, social and governance (ESG) factors in their analysis. This helps them to identify potential risks that could affect the long-term viability of lending, increase costs to the business or result in future litigation.

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

Cost

The fund’s standard ongoing charge is 0.56%, but we’ve secured a 0.19% saving for HL clients. That means a net ongoing charge of 0.37%, which we think is one of the best value actively managed options in the corporate bond sector. The HL platform fee of up to 0.45% per year also applies.

Performance

The fund has tended to do better than others in the corporate bond sector when the market's rising, but declined faster when it's falling. It struggled during the financial crisis, for example, but has generally performed well since. Investors who've been prepared to ride out the dips have been rewarded with excellent long-term performance. Past performance is not a guide to the future though and investors could get back less than they invest as the value of investments goes up and down.

More recently, the fund’s investments in the insurance and financial sectors have hurt performance, whilst lower rated bonds in the fund have also detracted. A flight to safety by some investors has meant increased demand for higher-rated bonds which subsequently outperformed lower-rated issues.

Past performance is not a guide to the future. Source: Lipper IM to 31/03/2020.

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