The Hermes Unconstrained Credit fund will invest globally in investment-grade and high-yield bonds, loans, credit-default swaps, asset-backed securities and other credit derivatives.
It has an options overlay to manage risks.
Head of fixed income Andrew Jackson (pictured), who manages the fund alongside Fraser Lundie, told Portfolio Adviser the fund would underperform if monetary policy tightens faster than market expectations, but said that is not the biggest risk for investors.
“The probability that rates will rise meaningfully faster is probably significantly lower than it was 12 to 24 months ago, which is why we’re relatively comfortable taking that view,” Jackson said.
Investors have been reducing duration as they worry about their fixed income allocation’s sensitivity to rising interest rates.
Massive outperformance
Jackson set out the various market conditions in which the fund would out or underperform, stating it will massively outperform in a big market sell off.
“Big rally, I think we’ll do very well because we’re slightly longer than we would be without the options. Small rally, we’ll do reasonably well because we’ve selected some really interesting securities.
“Small sell-off, we’ll underperform. If we have a small sell-off and sit there for a period of time, the carry from the fund will compensate us for that underperformance. We’ll get to par over nine months to a year.”
The fund is not set to outperform if rates move slightly faster than people expect and causes a slow and steady deterioration in markets, he said.
“That would be a circumstance in which we’d have to work very, very hard to keep pace.”
But the fixed income team is less confident on rate hikes from the UK and the US Federal Reserve than it was going into 2018, Jackson said. He added the likelihood of the ECB raising rates in the near is “very, very low”.
Jackson said: “What are the big risks people are worried about? Geopolitics has probably overtaken a really large increase in rates. People know rates are going to increase, they expect that.”
Quilter seeding
Quilter multi-asset is among the seed investors as the fund launches with £185m, much more than the £50m Jackson said would have been required to get the fund off the ground.
The fund holds approximately 15% in ABS, 10% in European leveraged loans and the rest in liquid credit.
It is yet to be allocated to an Investment Association sector.
Jackson would not name the capacity limit for the fund, except to say it is “not a £10bn fund”.
“We’re not buying the whole market,” he said.
It holds around 75 issues and does not participate in new issues. “We generally buy stuff that is well-established. We’re not beholden to banks, which means that we’re not a great counterparty to them when they want to get their new issues away.”
The fund is the first launched since Jackson was appointed head of fixed income in May 2017. It takes Hermes liquid credit fund range to five products.
