Invesco Perpetual Distribution - opportunities in financial bonds

Heather Ferguson | Tue 05 September 2017

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• Paul Read and Paul Causer, managers of the fund’s bond investments, retain a relatively cautious stance, although they see value in bonds issued by European Banks
• Ciaran Mallon has invested the fund’s equity investments in businesses with predictable earnings and sustainable, growing dividends
• Performance has been lacklustre in recent years, partly because the bond managers’ cautious stance has not paid off as the market has continued to perform well

Our view

The Invesco Perpetual Distribution Fund benefits from the experience of both the Fixed Interest and UK Equity teams at Invesco Perpetual. We have high conviction in Paul Read and Paul Causer to manage the bond portion of the fund, but we currently prefer to access their expertise through other funds they manage. In addition, Ciaran Mallon is not currently one of our preferred equity income fund managers. The experience and resources of the team as a whole means we believe they have the potential to deliver respectable returns over the long term, but we are not currently considering the Invesco Perpetual Distribution Fund for inclusion in the Wealth 150+ list of our favourite funds across the major sectors.

Performance & portfolio review

The fund experienced mixed fortunes over the past year. An expectation that the US government would implement policies to stimulate growth caused equities to perform strongly, which benefitted the fund over the first half of this year. Financial bonds, to which the fund is biased, have also been among the best-performing areas of bond markets, to the further benefit of the fund over this period. This strong performance helped to offset some of the weaker performance suffered during the second half of 2016, when some of the fund’s equity investments, including Capita and Essentra, detracted from returns following profit warnings.

Past performance is not a guide to future returns. Source: Lipper IM to 31/07/17

Overall, the bond portion of the fund has remained conservatively invested in recent years and this has dragged on performance. A persistent environment of low interest rates, low inflation, and moderate economic growth has driven bond yields to historic lows (and therefore prices higher). We have some sympathy with the view that such low yields are relatively unappealing and the market is vulnerable to a reversal in performance, but it could be some time before the current environment changes. We would expect the fund’s bond investments to hold up better than the wider market or peer group during a tougher time, although there are no guarantees.

The financial sector, particularly the debt of European banks, remains the managers’ preferred area of the corporate bond market. Against a backdrop of stronger regulation, banks have built large capital reserves and are in a more robust financial position, in their view.

Elsewhere, around 20% of the fund is invested in high-yield bonds. The managers have also found opportunities among ‘corporate hybrids’ in the telecoms and utilities sectors. These bonds give the company more flexibility than a traditional bond, to vary or cancel the interest payments, for example; or even redeem the bond early. The holders of traditional bonds will also usually get paid before the holders of hybrid bonds in the event the company becomes insolvent. These are higher-risk areas, but the managers feel they offer sufficient income to compensate for the additional risk. They also benefit from ‘low duration’, which reduces the portfolio’s sensitivity to an interest rate rise. Some cash is also held to allow the managers to pounce on opportunities thrown up by any sell-off. The managers have the ability to use derivatives, which if used, adds risk.

Around 35% of the portfolio is invested in company shares. For this portion of the fund, Ciaran Mallon continues to favour companies with predictable earnings and sustainable, growing dividends. Stalwarts of the portfolio include RELX, Experian, GlaxoSmithKline and Compass Group. British American Tobacco and Imperial Tobacco also feature in the fund's top 10 equity investments. These companies suffered a setback in recent months as investors worried about potential legislation to reduce nicotine in cigarettes to non-addictive levels. However, Ciaran Mallon continues to feel these companies represent an attractive investment opportunity.

Please read the key features/key investor information document in addition to the information above.