Banking bonds were one of the worst performers in the first quarter but now offer intriguing opportunities as they have not improved in line with the US economy, according to veteran investor Ken Leech.
Leech, who is CIO at Legg Mason subsidiary Western Asset, said, despite the US economic recovery, bank bonds had potential to grow. This has seen Leech increase his allocation to the sector during the first quarter.
‘We think banks still have room to improve pretty meaningfully. Our highest conviction has been US banks. We felt strongly that the tremendous weakening in spreads, and the prices of investment-grade bank bonds relative to treasuries, was misplaced,’ he said.
‘Our belief is that the business model of banks has moved from a riskier business model to a heavily regulated, almost utility-like business model. In conjunction with the enormous changes in capitalization, it makes the credit worthiness of the bond part of banks very powerful.’
Leech has the US as his largest country allocation in the Legg Mason WA Macro Opportunities fund, while, in terms of sectors, Leech holds 40.39% of the fund in investment grade credit bonds, which he thinks have performed well in the current economic environment.
‘You’ve seen this kind of reconnection between investment grade and treasuries. In an ongoing recovery we would expect to see the investment grade credit line with its higher yield and higher returns perform treasuries over time. We have seen that relationship restored,’ he said.
Leech remains positive on EM bonds and thinks they have reached the bottom. During Argentina’s recent issuance of bonds, Leech added to the fund and now has a 0.76% holding in the country.
‘We actually have an optimistic view of Argentina. It's an interesting situation where we have what we think are pretty compelling evaluations against a political change in regime and a commitment to rejoining the global community of nations. We were meaningful participants in the Argentina bond deal, and we're optimistic,’ he said.
Leech has a 3.82% allocation to Brazil and said the political situation has improved in the country. The manager has other holdings in South America, with 3.21% of the fund in Colombia and 7.4% allocated to Mexico.
‘The political paralysis that threatened to keep that country under siege for several years seems to be abating, and we're pretty encouraged that the new government will take a more friendly tack. From our perspective, evaluations were so punished that we think there are opportunities.’
The Legg Mason WA Macro Opportunities fund returned 3.1% in euro terms over the 12 months to the end of April 2016. This compares to an average manager return of -2.09% in the Bond Strategies sector over the same timeframe.