Financial bonds are the best way to hedge against an interest rates rise and achieve steady returns, according to Citywire AA-rated manager Anthony Smouha.
Speaking to Citywire Global, Smouha, who manages the GAM Star Credit Opportunities fund, said that banks, insurance companies and asset managers are all part of a secular theme that will see their capital reserves strengthen and credit quality improve.
‘Financial companies have been forced by the new regulation to clean up their balance sheets and offer a good interest carry to protect investors against rate rises,' he said.
The manager is significantly overweight financials and owns several investment grade companies to achieve a good level of protection and diversification in his portfolio.
Among his fund’s top positions are Lloyds Bank and Barclays, as he thinks they are two solid companies that are improving from a credit perspective.
Within Lloyds, Smouha prefers old subordinated debt as he thinks it will benefit from a smaller supply and higher demand in the near future.
He has also built up a 1.5% position in the new Man Group 2024 bonds since September, as he said the asset management business has a good franchise as well as a solid balance sheet.
‘We like the new management and we think the group’s organisation is very efficient,’ he added.
Financials encompass a wide range of companies, according to Smouha. ‘This is not just about universal banks. We like asset managers and insurances as well.’
He said asset management companies such as Aberdeen Asset Management and Man Group offer a rigorous business model. ‘Generally speaking, asset managers are not leveraged and boast very strong balance sheets.'
The same themes apply for insurance companies, he said, which are going to be more vigilant than in the past thanks to the Solvency II regulatory framework.
‘We like Aviva as it is a big player in this sector and has a very competent management,’ he said.
Elsewhere, the fund owns deeply discounted floating rate notes as Smouha thinks they offer good protection as well as potential for capital gains when interest rates rise.
‘A lot of new issues are fixed-to-floater bonds, where the coupon is fixed until the first call date within five to ten years and then is refixed periodically thus limiting exposure to interest rate risk,’ he added.
Over the past three years, the GAM Star Credit Opportunities fund returned 59.09%, while the Markit iBoxx GBP Financials benchmark rose 45.45%.