Over the past two years, we have increased the credit quality profile of the Invesco Bond Income Plus (BIPS) portfolio. Exposure to investment grade bonds has risen steadily. Within high yield bonds, we have increased the number of bonds we hold with a credit rating of BB and reduced our holdings in the lower credit rating categories.
The portfolio’s exposure to bonds rated B and below has rarely been lower. This part of the market is a natural hunting ground for the portfolio, given its objective to deliver high income to the board of the trust, to enable them to pay attractive dividends. So, why are we steering away from it?
There are two sides to this. One is that we see attractive alternatives, both in outright yields and as a balance of risk to reward. Since interest rates have risen, we have been happy with the yields on lots of higher quality bonds, in the BB and investment grade credit rating categories.
The other side of this positive is a concern that the yields offered on many bonds in the lower part of the quality spectrum do not justify the risks.
The Investment trusts exposure to lower quality bonds has continued to fall in the past couple of quarters (see above chart), even as this part of the market has been buoyed by better data on growth and rising hope that we will see a softer economic landing. High yield bonds have outperformed investment grade bonds.
Growth is good for high yield bonds. High yield bond companies tend to have more debt and therefore spend more on interest payments (coupons3) ,relative to the size of their earnings. So, they are more sensitive to changes in earnings. As an asset class, high yield bonds are more correlated with equities than interest rate-sensitive investment grade bonds and government bonds.
My reason for concern about lower-quality credit is not that I see an immediate risk of an earnings recession. It is to do with re-financing risk, the extent to which companies can afford to pay higher rates of interest. For several years before 2022, ultra-low interest rates enabled bond issuers to finance very cheaply, with historically low interest rates.
| European High Yield Index | USD High Yield Index | |
|---|---|---|
| Average coupon of new issues | Average coupon of new issues | |
| Issue year | % | % |
| 2018 | 3.75 | 6.43 |
| 2019 | 3.56 | 5.91 |
| 2020 | 3.76 | 5.55 |
| 2021 | 3.69 | 5.22 |
| 2022 | 6.44 | 7.10 |
| 2023 | 7.55 | 8.55 |
Bloomberg, May 2024
This changed in 2022. Higher interest rates meant that the high yield bond market had to adjust to remain competitive. The price of these low coupon bonds fell below face value, and new bonds were issued at much higher coupons.
The Invesco Bond Income Plus portfolio is built on fundamental credit research, which involves examining a company's financial statements and broader economic indicators to uncover a security's intrinsic value and bond selection. We are wary of the re-financing risk faced by many high yield corporate bond issuers, and we have reduced exposure to that part of the market. But that does not mean we will avoid it altogether.
I think these risks can bring opportunities at the level of individual companies. High yield bond companies will have to pay more interest. That is not a bad thing, especially if you are the creditor (the owner of the bond)! It is great news for the ability of the portfolio to generate income into the future. Nevertheless, some companies will struggle in this environment. We will be aiming to avoid them through careful credit assessment. Others will be able to manage.
We have already seen good companies coming to the market and paying coupons several percentage points higher than when they borrowed a few years ago. We were happy to invest and to get those coupons. For companies issuing high-yield bonds, the extra expense of issuing bonds at higher interest rates may outweigh any gain from higher earnings in an environment where growth is stronger and interest rates remain high.But through active management we can add good coupons to the Investment trust, where we have confidence in the ability of the issuers to pay.
Better inflation data prompted a strong start to the quarter, however, there was a sharp sell-off in August as positivity around interest rates was swamped by fears of a US recession. These fears gradually dissipated, and markets largely recovered by the end of the quarter.
In this video recorded at a private investor conference, fund manager Robin West sets out why UK smaller companies deserve closer attention with insights on some of the extraordinary businesses in the portfolio.
Over the last two years it’s become much easier to earn an attractive level of yield from bonds. Rhys Davies looks at how the improving opportunity set has boosted the level of income in the Invesco Bond Income Plus portfolio.
The spread refers to the difference or gap in yield between bonds of the same maturity but different credit rating.
One basis point (BPS) is 0.01%
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Invesco Bond Income Plus Limited
Invesco Bond Income Plus Limited has a significant proportion of high-yielding bonds, which are of lower credit quality and may result in large fluctuations in the NAV of the product.
Invesco Bond Income Plus Limited may invest in contingent convertible bonds which may result in significant risk of capital loss based on certain trigger events. The use of borrowings may increase the volatility of the NAV and may reduce returns when asset values fall. Invesco Bond Income Plus Limited uses derivatives for efficient portfolio management which may result in increased volatility in the NAV.
Data as of 11th June 2024, unless otherwise stated.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security, or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
If investors are unsure if this product is suitable for them, they should seek advice from a financial adviser.
Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns.
The yield shown is expressed as a % per annum of the current NAV of the fund. It is an estimate for the next 12 months if the fund’s portfolio remains unchanged and there are no defaults or deferrals of coupon payments or capital repayments. The yield is not guaranteed. Nor does it reflect any charges. Investors may be subject to tax on distributions.
Views and opinions are based on current market conditions and are subject to change.
For more information on our products, please refer to the relevant Key Information Document (KID), Alternative Investment Fund Managers Directive document (AIFMD), and the latest Annual or Half-Yearly Financial Reports. This information is available on the website: https://www.invesco.com/uk/en/investment-trusts/invesco-bond-income-plus-limited.html.
Further details of the Company’s Investment Policy and Risk and Investment Limits can be found in the Report of the Directors contained within the Company’s Annual Financial Report.
Invesco Bond Income Plus Limited is regulated by the Jersey Financial Services Commission.
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