UK bank bonds worth the risk, Fidelity's Spreadbury says

Ian Spreadbury, manager of the Fidelity Moneybuilder Income fund, a pick of Citywire Selection, believes the risk of default on RBS and Lloyds bonds has fallen to a level that makes them an attractive investment.

Adding bank bonds

Fidelity Moneybuilder Income manager Ian Spreadbury has started to add medium-dated bonds in the UK's banking sector over recent weeks, despite his long-term aversion to financials.

Spreadbury has bought covered bonds in both Royal Bank of Scotland (RBS.L) and Lloyds (LLOY.L), which he believes offer a high degree of security, while currently priced at an attractive spread over government bonds.

He has a longstanding underweight to the financials and insurance sectors because of credit risk and regulatory and growth outlook concerns, but believes the default risk on bank bonds has been substantially reduced in the past few months.

This view has led him to look more closely at some of the higher risk bank bonds on 9 and 10% yields, although he has yet to buy into them.

‘You can pick up Lloyds and RBS on 9-10% yields for five- to six-year fixed dated bonds, and I think this looks outstanding value,' Spreadbury said. ‘A lot of the rubbish has been offloaded from the balance sheet, and while the risk remains that these banks could be bailed in, both have much stronger core tier-one ratios than they did three years ago.’ He said that Lloyds's tier-one ratio, the core measure of a bank's financial strength, is currently around 10% with RBS's ratio around 9%.

Spreadbury has also been adding to a senior-debt bond in Dutch bank Rabobank, which is dependent on the bank keeping its tier-one ratio above 7%. ‘It is a highly rated bank, and we think we are being paid quite well for the risk,’ he said.

Pockets of value in corporates

Elsewhere, Spreadbury sees quite a few ‘pockets of value' in corporate bonds. His biggest position remains an investment in the UK treasury war loan, which represents 2.7% of the fund and which he believes to be better value than long-dated UK gilts. Initiated in 1917 with a 5% coupon, the bond was restructured in 1931 with a 3.5% coupon.

‘We bought the bonds at 90p two months ago,' he said. 'The coupon is 3.5% and it is callable. Long-dated UK gilt yields are at 3%, so we are taking a view that it will get called by the government at par.'

Another key holding is the fund’s ninth-largest position, a bond in train-leasing group Great Rolling Stock, which is yielding 6.875%. ‘The risk with this is that the train company goes bust, but in practice the government has to step in as the operator of last resort,’ he said.

Upping regulated utilities

Another key infrastructure investment is in sixth largest position, Aspire Defence Finance, which is currently engaged in the reconstruction of military property on Salisbury Plain. ‘They are almost halfway through the project, so most of the construction risk has gone and they are ahead of schedule. The spread was 200-300 basis points above government bonds for something which is effectively government backed,' he said.

Spreadbury has also been upping his exposure to regulated utilities over recent weeks as the spreads for government bonds have widened.