Mark Dampier: By Jupiter, here's a bond that can still buck the trend
Friday 25 January 2013
Reading the business and personal finance pages of the national press over the holiday period and beyond might have led investors to conclude they should sell their bond funds to buy equities. In the investment world things are never so easy. Few articles I read really explained the diverse range of bonds and bond funds now on offer.
I accept that Western sovereign bonds, particularly UK gilts, German bunds and US Treasuries, look expensive relative to history. Yet the UK and Europe still face significant economic headwinds. The debt burden, unemployment, and social unrest afflicting some southern European nations could spread to the core.
Furthermore, I do not see interest rates rising in the foreseeable future. Ten-year gilt yields have ticked up to around 2 per cent from their summer low of 1.47 per cent. At the same time the Government's Funding for Lending scheme (where funding is provided to banks on condition they meet targets for lending to consumers and businesses) has caused deposit rates to edge down. Funding for Lending has reduced the need for, and hence the incentive to provide attractive rates on, retail deposits.
Taking all this into account, I cannot see yields on gilts or bunds rising much from current levels. If they did buyers would be attracted, especially with deposit rates so low. The increased demand would likely push prices higher (and yields lower) again.
This leads me neatly to Jupiter Strategic Bond. Ariel Bezalel, the fund's manager, has been stressing that there is still value in certain bonds. He has been buying into bonds issued by pub companies. He focuses on those at the top of the capital structure, meaning they are secured against property (the pubs). They are offering yields in the region of 7 per cent to 8 per cent and are redeemable over the next five to eight years.
Exposure to high yield bonds is around 60 per cent, the highest level for some time. Half of this is in senior secured debt near the top of the capital structure. Mr Bezalel has concentrated on businesses he believes can survive through thick and thin such as those in the packaging and gaming industries.
He argues the high yield market is neither expensive nor cheap. Yet he can't see what factors could cause the spread between yields on gilts and high yield bonds to widen over the coming 12 months. If yields did rise on high yield bonds, widening the spread, the consequent falls in price could result in capital losses for investors. However, in a low growth, low inflation environment he sees the hunt for yield continuing and high yield bonds remaining popular.
That said, Mr Bezalel is not blind to the world's economic problems. He suggests the US is the most likely source of further woe this year. It is ahead of the rest of the world in coming out of recession. He believes later in 2013 the Federal Reserve might cease its quantitative easing (QE) programme if the recovery takes hold. Being a strategic bond fund he can take short positions to benefit from falls in asset prices. Presently, a short position in US Treasuries accounts for 26 per cent of the portfolio. This has been a successful trade recently.
We might be near the end of a 30-year bull market for bonds, but I think it is premature to announce their death. Investors need to be more selective over what they buy. I think there are benefits to backing quality fund managers at the helm of more flexible strategic bonds funds. The Jupiter Strategic Bond has been a top performer since launch in June 2008, growing by 67 per cent compared with 29 per cent for the average fund in the IMA Sterling Strategic Bond Sector. As I write it also offers an attractive yield of 5.4 per cent.
I would not be surprised to see short-term cash deposit rates below 2 per cent in the near future. Even today, tying up your money for over a year gets you little more than 2 per cent. With interest rates set to remain low I still think there is life in bonds for investors willing to be a little picky.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent
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