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Phil Milburn, Kames Capital

Conditions ripe for investors to take more credit risk in 2017, says Kames Capital

Market conditions are ideal for investors to take more credit risk in 2017 provided inflation remains relatively muted, according to Phil Milburn (pictured) and David Ennett at Kames Capital.

The pair, who co-manage the GBP1.1bn Kames High Yield Bond Fund, say that barring an inflation shock, next year should provide a fertile hunting ground for investors seeking more value from the riskier parts of the fixed income market.
“If we can discount rampant inflation from the equation – although we may see a scare in the spring – we think conditions are ideal to take more credit risk to find value in 2017,” says Milburn.
“For us, investments with single B ratings are the sweet spot. We really like things with a five- to seven-year maturity and a decent yield. Also we prefer assets with a return that is not unduly dependent on huge geopolitical changes falling on the right side of history.”
On that basis the managers say they are avoiding peripheral Europe and emerging markets’ corporate bonds. “In the latter case there is often an awful lot of debt on the balance sheet and nearly always a currency risk because most are issued in hard currency but earnings are frequently in local currency,” says Ennett.
“We like companies with repeatable revenue streams, like cable TV operators and logistics companies. XPO Logistics, for instance, is throwing off cash and deleveraging after acquisitions. Bonds were issued at cheap levels on the understanding that there would be synergies, boosting cashflow and profitability in the long run.”
While the US healthcare sector faces major headwinds - not least how much of Barack Obama’s Affordable Care Act is repealed under president-elect Trump – the managers say they like specific stocks such as Hospital Corporation of America (HCA), and favour select opportunities in the pharmaceutical sector.
The managers highlight the energy sector in particular as presenting attractive opportunities in the coming months. While defaults have risen since early spring – with approximately one in eight companies in energy and metals and mining unable to service their debt burden – a market rout has not materialised. Instead, lenders, unlike in previous bust cycles, have continued to refinance energy companies, while a ‘sensible’ repricing has left stocks trading at levels that better reflect their risk of default.
“There was a huge clear out but with repricing, refinancing – and the poorest performers no longer cluttering things up – the sector looks well set and we have seen some encouraging price rises that should continue into 2017,” says Milburn.
“While we have witnessed some spectacular crashes in the past year, we are actually quite sanguine about the market. Pockets of uncertainty remain but there are lots of good, solid investments across the board."

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