Annington: harnessing transformational events in corporate bond investing

As with any investment, your capital is at risk and income is not guarenteed.

The word transformational is not typically associated with corporate bond investing. The best-understood approach to outperforming an index in this asset class is excess income. Put simply, if a portfolio of bonds generates a greater yield than the index, it stands a chance of outperforming it.

However, corporate bonds can also deliver relative outperformance through price appreciation. For example, when a corporate bond issuer’s financial health improves, this could lead to a fall in the perceived risk of default leading to an increase in bond prices.

One such opportunity is in bonds issued by companies in a category we describe as ‘event-driven opportunities’, where we believe a single transformational event would rapidly and materially improve a company’s balance sheet, resulting in sharp price appreciation.

Corporate bond return expectations

The challenge with identifying these opportunities is that analysing their potential for success is hard, they are few and far between, and the timeline over which they might play out can be drawn out and uncertain. However, we believe our unique approach is suited to overcoming these challenges as we seek to add value for our clients.

Annington and the Married Quarters Estate

In 1996, Annington purchased a 999-year lease on the Married Quarters Estate from the UK Ministry of Defence (MoD). As part of the deal, the MoD leased back these properties and agreed to meet the cost of renovations. This transaction, designed to generate capital to fund refurbishments, proved to be a great deal for Annington and a poor deal for UK taxpayers.

Annington has been a well-known issuer in the UK corporate bond market for decades. Our interest in this company changed in late January 2022 when the MoD confirmed that it was exploring its right to buy back the Married Quarters Estate. This announcement followed a rumour that Annington’s owners were seeking to sell the company having recently negotiated a new rental agreement.

The revised terms reduced the risks associated with Annington’s business. It was now an attractive asset, offering a long-term, low-risk and inflation-linked revenue stream to prospective buyers. However, a profitable sale would be embarrassing for the UK government. The MoD indicated it would do everything in its power to engineer a re-purchase.

In this context, the market focused on the short-term risk that the MoD could force a sale at a price that might lead bondholders to suffer losses. We focused on the long-term investment potential. Bond prices already reflected the worst-case outcome.

Our analysis suggested a deal would be reached and, in most scenarios, that would be a good thing for bondholders. We decided to purchase the bonds and wait.

Fast-forward almost three years, and the UK government agreed to pay almost £6bn for the Estate in December 2024, ending one of the most controversial privatisation deals in British history.

Annington: excess return

While Annington agreed to a below-market valuation, the price was attractive and the deal ended all litigation. A transformational event had taken place. Existing bondholders were handsomely rewarded in the months that followed, as the disposal proceeds were used to repay Annington’s outstanding debt.

Research-driven, high conviction, patient and flexible

Investments in Annington bonds were among the largest contributors to the strong performance delivered by the Baillie Gifford Investment Grade and Strategic Bond Funds in 2024. This is a great example of our philosophy and process adding value in practice.

Our research-driven approach means that our analysts have the space and time to produce in-depth research and form a differentiated view. This gave our managers the confidence to buy at attractive prices in January 2022 and at a scale that had the potential to add significant value.

Patience and our long-term investment horizon were also key to the success of this investment. Our managers are incentivised over five-year investment periods, encouraging them to make decisions that will have the greatest impact on returns over the long term.

For much of 2022, 2023 and 2024, Annington was a sleeper agent in our corporate bond portfolios, contributing little to relative performance. We didn’t know exactly when a transformational event would happen, but we were confident that it would. In the event, our positions in Annington bonds paid off handsomely for our clients.

Past performance

Annual Past Performance to 31 December Each Year (%)

Source: FE, Revolution, ICE Data Indices. Total return net of charges, in sterling. Class B Inc. Share class returns calculated using 10am prices, while the Index is calculated close-to-close.

*70% ICE BofA ML Sterling Non Gilts Index / 30% ICE BofA ML European Currency High Yield Constrained Index

**IA £ Strategic Bond Sector

The manager believes that appropriate comparisons for this Fund are the Investment Association Sterling Strategic Bond sector average, given the investment policy of the Fund and the approach taken by the manager when investing and a composite index comprising 70%: ICE BofA Sterling Non-Gilt Index and 30%: ICE BofA European Currency High Yield Constrained Index (hedged to GBP) being representative of the strategic asset allocation of the Fund.

Annual Past Performance to 31 December Each Year (%)

Source: FE, Revolution, ICE Data Indices. Total return net of charges, in sterling. Class B Inc. Share class returns calculated using 10am prices, while the Index is calculated close-to-close.

*ICE BofA sterling Non-Gilt Index

**ICE BofA sterling Non-Gilt Index plus +0.50% to 16 September 2022; thereafter ICE BofA sterling Non-Gilt Index plus +0.75% per annum, over rolling three-year periods. The indices have been chain-linked for performance figures above.

***IA £ Corporate Bond Sector

The manager believes this is an appropriate target given the investment policy of the Fund and the approach taken by the manager when investing. In addition, the manager believes an appropriate performance comparison for this Fund is the Investment Association Sterling Corporate Bond Sector. There is no guarantee that this objective will be achieved over any time period and actual investment returns may differ from this objective, particularly over shorter time periods.

 Past performance is not a guide to future returns.

Important information and risk warnings

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in March 2025 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

This communication contains information on investments which does not constitute independent research.

The Fund's share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.

Bonds issued by companies and governments may be adversely affected by changes in interest rates, expectations of inflation and a decline in the creditworthiness of the bond issuer. The issuers of bonds in which the Fund invests, particularly in emerging markets, may not be able to pay the bond income as promised or could fail to repay the capital amount.

Further details of the risks associated with investing in the Fund can be found in the Key Investor Information Document or the Prospectus, copies of which are available at bailliegifford.com.

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.

All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.

The images used in this communication are for illustrative purposes only.

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