Manager Insight

Matt Brill shuns overseas issues with negative yields.
By Michael Ryval | 18/01/18

Though some major central banks are in a tightening mood, Matt Brill, a fixed-income specialist with Invesco Fixed Income, a unit of Atlanta-based Invesco Ltd., remains upbeat about the asset class. He is particularly hopeful for North American corporate bonds.

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

"Yields are at the lower end around the globe and valuations are not as compelling as they have been in the past, but we are not fearful of materially higher rates," says Brill, a senior portfolio manager on the team managing the $308-million Invesco Global Bond.

"First, there is demographic support," Brill says. "Aging populations around the globe have a strong demand for fixed income. That provides a ceiling for interest rates."

Second, Brill notes that inflation is extremely low, largely due to technology-driven efficiencies. "This leads to a lack of inflation. And if you don't have inflation, you don't get higher rates," says Brill, who shares duties with Michael Hyman, Sean Connery, Ray Uy and Todd Schomberg.

Significantly, the yield curve is appearing to flatten as the Federal Reserve has hiked rates four times since December 2015. Yet the 10-year Treasury, which determines where longer rates are going, has barely changed since then. Currently in the U.S., the yield on 10-year Treasury bonds is only 120 basis points higher than that of three-month Treasury bills.

"You are getting a flatter yield curve," says Brill. "We have to remind people that the Fed only controls overnight rates. But the markets determine the rest of the curve. And, importantly, the back end is staying almost the same."

The Invesco team in Atlanta, which manages in aggregate about US$300 billion in fixed income assets, is favouring North American bonds, and underweighting Europe and Asia. "Roughly 40% of Europe trades at a negative yield and about 20% of the globe have negative yields," says Brill. "We want to be in the areas with positive yields, because buyers in countries with negative yields will be forced into areas with positive yields -- and that's the U.S. and Canada."

As for credit quality, the sweet spot is in investment-grade corporate bonds, says Brill. "If you take on too much credit risk and overweight high-yield bonds, you will be very correlated to the equity market. We don't want to do that. We want to act like a bond fund."

Investment-grade corporate bonds provide additional spread over government treasuries, says Brill. "But if that environment was to change and there was a pick-up in volatility, and maybe we slip into recession in a couple of years, you are much better off from a credit standpoint than if you go heavily into high-yield."

The Invesco team isn't avoiding high-yield bonds altogether, Brill notes. Rather, it is focusing on BB-rated bonds, which are one notch below investment grade. "Economies are growing. But the valuations are not there. You are not getting paid enough to buy B and C-rated bonds," says Brill. "You have to be more careful in that area."

Brill adds that recent tax reform in the U.S. will limit the ability of indebted corporations to deduct their interest expense. In effect, companies with too much debt will be encouraged to de-lever and may see their bonds re-rated upwards. "Tax policy will discourage leverage by corporations and as some bonds are upgraded we want to take advantage of that."

Invesco Global Bond, introduced in May 2016, should be regarded as "ballast" for an investor's portfolio. "The goal of the fund is to give you income, diversify away from equities and be a preserver of capital," says Brill. The fund's running yield is about 2.8%, after fees.

The fund holds about 33% in North American investment-grade credits, versus 12% in the benchmark Barclays Global Aggregate Bond Index (C$). There is 7% in a mix of European and UK corporate credits, 10% in corporate high-yield bonds and 7% in emerging-markets bonds. There is also 30% is held in sovereign bonds, mostly from the U.S. The balance is in structured securities such as commercial mortgage-backed securities. The fund is almost entirely hedged back to the Canadian dollar.

"There is money to be made in investment-grade corporate bonds and in global bonds," says Brill. "However, we have to be a little more cautious than we were a year ago because valuations are not as attractive as they once were."

The portfolio, which has a duration of six years, or about one year shorter than its benchmark index, holds about 300 securities. One representative issuer is the U.S. pipeline company  MPLX LP (MPLX). "It's going to continue reducing its debt paying down debt," says Brill. "And it's very focused on remaining investment-grade."

Brill says bond-market valuations are fair, at best. "The biggest risk is that central banks get over-hawkish and drive growth slower and potentially push economies into recession. The risks are low," he says. "However, we are very keenly aware of them. The flattening of the yield curve (in the U.S.) is not a good sign. So we are watching the central banks: will they over-shoot in terms of raising interest rates?"

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