The company’s First Rail business is the UK’s largest rail operator, with three government-contracted operations (Avanti, GWR and SWR) alongside its open-access rail operations. First Rail operates around 24% of the UK rail market and undertakes over 770,000 passenger journeys each day. 

The road to net zero

The group has positioned itself as a solution provider in the energy transition: First Bus expects to have four fully electric depots and around 600 zero-emission buses in its fleet by March 2024, and has committed to operating a zero-emission bus fleet by 2035. Meanwhile, First Rail is working with its partners to cut carbon emissions, including the introduction of electric trains to replace diesel where possible (1) 

We have built a position in FirstGroup’s 6.875% bond due in September 2024, which has a compelling yield to maturity and spread versus gilts. The bond is BBB rated and has one year to maturity. Issued in 2009 – at a point when interest rates were much lower – it offers an attractive income alongside potential for capital growth (the ‘pull-to-par’ effect) as it approaches maturity. 

Navigating an uncertain world 

Against an uncertain backdrop, short-dated bonds offer appealing risk-adjusted returns. The inversion of the yield curve has allowed investors to receive additional income without increasing duration risk. Because of its short-dated focus, our portfolio has a shorter duration profile than a typical bond fund with duration of between two and three years contributing to lower volatility. 

We prefer to hold bonds to maturity, and we tend to keep at least 10% of the fund in bonds that are set to mature in less than one year. This results in a portfolio with good liquidity, a constant runoff of maturing bonds, and interest coupon payments that can be reinvested, with a yield-to-maturity of around 6.8%(2) on the underlying holdings. 

Wider horizons

 Whereas a bond will fall out of the benchmark iBoxx Sterling Corporates (1-5 Year) Index once its maturity falls below one year, under our mandate, we are not obliged to sell an asset once it runs off the benchmark, unlike many of our peers. This freedom will allow us to retain FirstGroup’s bond – a high-quality asset with an attractive yield – until it matures. 

A choice of investment destinations

 We also have the ability to invest in bonds with a maturity longer than five years if they are attractively valued. This allows the fund to invest ahead of a bond’s benchmark inclusion, unlike index funds which may be restricted to the one-to-five-year investment universe.

We may also invest in high yield bonds, enabling us to identify possible ‘rising stars’ with the potential to be re-rated from junk status to investment grade status. We place considerable emphasis on issuer selection and have the flexibility to invest in non-sterling-denominated bonds, and around 50% of the sterling corporate bond index is composed of non-UK issuers, resulting in a wide distribution of countries, sectors and issues. 

Keeping your client’s investment journey in mind

This flexible, balanced philosophy, with a clear focus on both income and capital growth, is designed to help your client benefit from strong total returns in the long term.

Visit our Investing for Income campaign page where you can read our other case studies and find out more about our total return mindset.  

Companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance. Past performance is not a guide to future results.