1. New Year,
    New Conviction

  2. January 2019

     

    The value of an investment in the fund, and any income from it, can fall as well as rise and investors may not get back the amount invested.

  3. At the start of what looks set to be an eventful 2019, fixed income specialists Lucy Isles and Robert Baltzer reflect on how the Baillie Gifford High Yield Bond team’s focus on resilience and good governance has positioned it for a more febrile market.
  4. What a difference a year makes. Throughout 2018 the accumulation of evidence of the ending of the long positive credit cycle gathered pace, especially over the summer. The tone is markedly different from this time a year ago. We stand at the start of a new year with central bank support winding down, previously ultra-low default rates rising, and a general air of expectation that markets are entering a more feverish phase.

    In the high yield bond market prices have fallen, yield spreads have widened, and the pace of issuance has slowed markedly. Conviction is being tested as jittery investors punish companies issuing profit warnings or suffering from general problems in their sector: Italian or Spanish construction firms for example or US or European retailers. Events that are well within a predictable range of outcomes are being received more anxiously than they were a year ago.  

    For the Baillie Gifford High Yield Bond team, the task has been to continue the cautious positioning of portfolios we began in 2017. Our focus on resilient companies has served us well. Now we stand ready to use this period of irrational jitters as an opportunity to buy what we see as temporarily underperforming but fundamentally sound businesses.


    Annual past performance to 31 December each year (%)

      2015 2016 2017 2018 2019

    The Baillie Gifford High Yield Bond

    0.2

    10.1

    8.1

    -2.5

    11.9

    IA £High Yield Sector

    -0.7

    10.1

    6.1

    -3.2

    10.1


    Source: FE, IA. Single pricing basis, total return in sterling. B Inc shares.

    Past performance is not a guide to future returns.

     

    Take Intralot, a well-diversified global gaming company we believe is poised to benefit from the recent liberalisation of the US sports betting market. Intralot originated in Greece, and still has heavy exposure to various emerging markets and volatile currencies. Its bond price dropped dramatically due to its exposure to Turkey, which faced a torrid time in 2018, and Argentina, where Intralot’s earnings were hit by a currency in freefall.

  5. © Intralot.
  6. We chose to add to our position at exactly the time market aversion to Turkey was at its highest, because we saw the price reaction as having little to do with Intralot’s fundamental resilience and everything to do with Turkey’s political travails.

    Likewise with Townsquare Media, a US radio network and media company whose bond was significantly underperforming at the start of 2017. This was partly due to ill-conceived mergers and acquisitions activity but more because of market hostility to perceived ‘old media’ in an age of technology-driven disruption. We were more interested in Townsquare’s 15 per cent share of a fragmented market that is in fact proving more resilient than most media against web-based destruction, also its new, more focused management team. We took advantage of low prices to add to our holding.

    Whatever 2019 has in store, we are determined to maintain the emphasis on environment, social and governance (ESG) analysis, which has weighed heavier on our decisions throughout 2018. One tangible result was that last year was the first in which we made sell decisions about companies whose financial performance was perfectly acceptable, but which fell short when viewed more systematically through an ESG lens. Now we review all potential new additions to the portfolio as well as working through all those we already hold. Roughly 60 per cent of our portfolio has been checked, and we aim to achieve 100 per cent by the end of this year.

    This is an exciting new development, and we expect to be able to evidence its value in the near future.

    A good example of how our engagement on ESG matters stepped up a gear in 2018 is Herbalife, the California-based global nutrition supplement marketing company. Here our governance discussions with management allowed us build up enough conviction to take an unfashionable position. Once a target for short-sellers, and a US Federal Trade Commission investigation, which ended in 2016 with a $200 million fine but without the threatened designation as a pyramid scheme. Our interest in the company began when Lucy approached Herbalife in the guise of a potential distributor and was able to find sufficient reassurance in the company. Later this year, Lucy and our team’s now dedicated Governance and Sustainability analyst, Laura Thomson, probed management on potential ESG flashpoints and received the comfort they sought.

    © Getty Images/WireImage
  7. So what does 2019 hold in prospect? If it really is the case that we are entering a new and difficult phase of the credit cycle, we are in for interesting times. We need to continue to be vigilant about our existing holdings and maintain last year’s sell-discipline, given the likely extra challenges posed by a new environment where valuations are more widely dispersed.


    Chances are we will see more instances of attractive valuation opportunities emerging. Our focus will be on seizing the moment, and avoiding the risk of complacently nursing a high-quality, but expensive portfolio.


    Not only would that be exactly the wrong response to the many exciting opportunities we see emerging in 2019, it would be a waste of the strong position we have earned ourselves over the last year and more. Whatever the new year may have in store, we feel ready to respond.

      

  8. IMPORTANT INFORMATION AND RISK FACTORS

    The views expressed in this article are those of the High Yield Bond team and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions. Baillie Gifford & Co Limited is authorised and regulated by the Financial Conduct Authority (FCA). 

    This communication was produced and approved in January 2019 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

    Investment markets can go down as well as up and market conditions can change rapidly. Bonds issued by companies and governments may be adversely affected by changes in interest rates, expectations of inflation and a decline in the creditworthiness of the bond issuer. The issuers of bonds in which the fund invests may not be able to pay the bond income as promised or could fail to repay the capital amount. The fund’s concentrated portfolio relative to similar funds may result in large movements in the share price in the short term.

    Derivatives may be used to obtain, increase or reduce exposure to assets and may result in the fund being leveraged. This may result in greater movements (down or up) in the price of shares in the fund. It is not our intention that the use of derivatives will significantly alter the overall risk profile of the fund. Market values for securities which are difficult to trade may not be readily available, and there can be no assurance that any value assigned to them will reflect the price the fund might receive upon their sale. Custody of assets involves a risk of loss if a custodian becomes insolvent or breaches duties of care.

    This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.

    All information is sourced from Baillie Gifford & Co Limited and is current unless otherwise stated.

    The images used in this article are for illustrative purposes only.

     

    Ref: 44858 IND WE 1223

  9. Lucy Isles

    Lucy joined Baillie Gifford in 2012 and is co-manager of the High Yield Bond Fund. Lucy graduated MA (Hons) in International Relations and Modern History from the University of St Andrews in 2011. 

  10. Robert Baltzer

    Robert joined Baillie Gifford in 2001 and is Head of the High Yield Team, and co-manager of the European High Yield and Global Credit strategies. He is a CFA Charterholder and graduated MMath from the University of Durham in 2001.