In it for the duration
No doubt about it, Woolnough has proven his mettle over time with Optimal Income, predating the IA sector, and that is exactly why he manages so much money.
The ethos behind that fund, he says, is to unbundle duration and credit risk. The portfolio has a shorter duration than a conventional bond fund and, relative to its duration position, twice as much credit risk.
“The main driver of what we have been doing, is that we think the world economy is healthier and stronger than other people do,” he says.
“Even in the face of falling unemployment in the UK and US, the bond market has continued to march on, and so I think being under duration has been a negative for us over the past two or three years. Saying that, we have hardly been long duration for the whole bull market because we find it hard to get excited about bond yields at these levels.”
The bias presently in that fund is towards investment grade, which Woolnough believes looks relatively cheap versus high yield. He explains that the heavy supply of credit that has been engendered by the huge rise in M&A activity over the past year has made some areas particularly attractive.
Consolidation activity from the likes of AT&T and Horizon has caught his interest “When these big corporate acquisitions occur it quite often means their debt financehas a huge supply of corporate bonds and that gets absorbed. It does not sit there as some kind of illiquid thing that nobody will clear. When the SABMiller and AB InBev deal happens there might be £50bn worth of debt coming, that shows the markets are liquid because you can get £50bn worth done.
“When it happens, it comes at a discount because corporates need to raise the money to complete their acquisitions.” Woolnough holds a negative view on the oil sector, which he believes still faces difficulties.
He says: “It might be OK for an equity investor to participate in energy securities because they will benefit greatly if the oil price goes up.
“But from a risk/reward perspective for a bond investor, if the oil price stays low, the ratings of those companies will deteriorate and the bond price will suffer.”
Winds of change
With this in mind, Woolnough asserts that the low oil price is actually a good thing for investors – the fall in the oil price being beneficial to the G7 countries that are net consumers of oil.
He says: “It is a huge tailwind for our economic growth, while being a terrible headwind for those that produce it. This is exactly the reverse of the 2007-09 period.”
Woolnough identifies two defining features of the financial crisis – one being the housing market, and the other being oil reaching $150 per barrel. “It was exceptionally painful for the west – a high oil price is a tax on growth, a tax on inflation and exposes fragility in the financial system. That is not good for us but when we have good deflation with falling oil prices, that is good for the economy. It will drive up GDP growth in Europe and the UK next year and it is one of the reasons why everybody will have more disposable income.
“If you want to get something done quicker, with better quality and at a lower price than last time, that is deflation.”
So what of wealth managers’ views on illiquidity in the bond market? Are they right to be concerned? Woolnough acknowledges that this is the “topic of the day” but cites a record issuance of US corporate bonds averaging $100bn in the “difficult” month of September, suggesting there are willing buyers and sellers.
He says: “There are a lot of the measures that get sent around to do with inventory and cost of dealing that all point to the idea that liquidity is the worst it has been in a number of years. This is taking some type of theory to work out what liquidity is.
