M&G Credit Income (MGCI) has shunned buying into the US hyperscaler borrowing binge to fund the rollout of artificial intelligence (AI) as fund manager Adam English maintains his defensive posture amid a darkening economic outlook stemming from the US-Iran conflict.
In the loan and bond fund’s third quarter update English said: “The company has not participated in recent hyperscaler debt issuance on relative-value grounds and currently has limited exposure to AI-themed issuance. We continue to favour defensive corporate issuers supported by tangible assets and predictable free cash flow,”
That means English, who has managed the £191m investment trust since launch in 2018, avoided Amazon’s debut sterling bond launch in September. The e-commerce and cloud computing giant drew in £4.25bn ($5.76bn) in a reportedly over-subscribed offering with $10.65bn of orders.
Investors, other than English, were attracted by the bonds’ yields which ranged from 5.2% on a three-year tranche to 6.7% on the longest 19-year term.
His comment follows the Bank of England’s Financial Policy Committee noting in September that AI hyperscalers accounted for 47% of all sterling corporate bonds this year.
Globally, according to Reuters, Amazon, Alphabet, Meta and Oracle raised $194bn in bonds issued from 1 January to 7 July as their AI spending needs outpaced their previously healthy cash flows.
English said: “The scale of AI-related debt issuance is increasingly influencing pricing dynamics in fixed income, while the financing required to support AI infrastructure is shifting some technology-sector risk from equity to credit markets.”
Although economic activity in the UK and Europe had so far proved resilient, English said higher energy prices, persistent inflation and rising government borrowing costs presented a “more demanding backdrop” for corporate borrowers and investors.
English said higher refinancing costs were “unlikely to result in widespread distress among investment-grade borrowers,” adding, “it is likely to place greater pressure on weaker business models and highly leveraged issuers.”
As a result, English continues to favour high-quality credits in the 134-stock, mostly sterling-denominated portfolio, although he said investment grade valuations remained tight.
MGCI made an underlying return of just 0.81% in the three months to 30 September, underperforming the 1.8% gain in its SONIA plus 4% benchmark. The portfolio’s low-duration positioning of 1.1 years helped offset the fall in government bonds as their yields jumped in anticipation of higher interest rates. This left it up 3.2% since the start of the year, again below the 5.8% return from its benchmark. The trust holds 75.6% of its assets in investment grade bonds and cash.
However, this positive stance was offset by the manager’s skirting clear of higher yield bonds to preserve longer-term returns and by broader weakness in credit markets.
Over the quarter English said he continued to recycle capital from publicly traded holdings in the 7.3%-yielding portfolio into “more compelling” opportunities in private bonds, loans and asset-backed securities.
Disposals included a £1.2m holding in Luxembourg real estate company Aroundtown, which he bought in the 2022-23 selloff when interest rates surged after Russia invaded Ukraine and sold at “notable capital gain”. A further £2.1m of strongly performing bonds form Center Parcs and fund manager Quilter were also sold.
MGCI shares stand on a 0.5% premium to their net asset value, which has enabled it to steadily issue new shares. It has delivered a total return of 35.6% over five years, including the quarterly dividends.
