Mark Dampier: Gilts have room for one last hurrah
Saturday 29 August 2009
I will return to the bond market this week, which continues to be a hot topic of conversation in investment circles. I have recently had two interesting conversations with Stewart Cowley, who is head of fixed interest at Old Mutual and manages the Old Mutual Global Strategic Bond Fund.
The mandate of this fund enables him to invest just about anywhere when it comes to bonds, such as government bonds, corporate bonds and currencies across the globe. Mr Cowley formerly worked at Newton, where he used to manage significantly more money, but he wanted to make his mark in the more boutique culture at Old Mutual.
One of the biggest debates at the moment is whether we should be worried about inflation or deflation. If either deflation or high inflation take hold, they can seriously cripple an economy, while it is generally accepted that a low level of inflation is the least-worst outcome.
In some countries there is already deflation, and in the UK, if we use the RPI index, deflation is here. However the CPI index (the official measure of inflation) is still showing inflation of 1.8 per cent. Mr Cowley believes that we face no inflation problem at the moment, indeed the problem is that most of the money injected through quantitative easing is locked up in the system (and, therefore, is not filtering through to the general public).
His most controversial view is perhaps that he thinks gilts could easily have one last hoorah before the seemingly inevitable bear market. He expects the yield on a 10-year gilt could fall to around 2 to 2.5 per cent. If that happens then, in capital terms, you would make around a 20 per cent profit. Before you get too carried away remember that this is not a trade for the faint-hearted – at some stage over the next few years, inflation will start to come back into the system and the possibility of the credit worthiness of the UK or US being downgraded cannot be ruled out.
Bonds, and corporate bonds in particular, have remained hugely popular with private investors, leading many commentators to suggest a few months ago that this was a bubble. At the time I argued this view was nonsense, since, for there to be a bubble, there had to be a huge overvaluation and this clearly wasn't the case. Even after this sharp rally there is still good value to be found, but you have to buy more carefully, with stock selection being the key.
One of the biggest calls over the next few years will be neutralising the danger of rising yields. Many people will struggle to achieve this, but one of the beauties of buying into a strategic bond fund is that you can leave it to the fund manager to do the job for you. That's not a guarantee, but my feeling is that a professional has a far better chance of getting it right than most private investors.
For the time being I believe that bonds will continue to do well. Interest rates are not going to go anywhere for at least a year, possibly 18 months, while unemployment is still rising and will continue to do so for the next two or three years. Taxes will rise next year and the public sector should, by any measure, be cut back. All of this is taking money out of consumers' pockets and, while I can see a recovery, it is going to be a long, slow grind – not a big lurch up.
My conclusion is that corporate bond funds, while unlikely to repeat the last six months in terms of capital growth, are still likely to do better than cash. Some investors may be better off investing in a strategic bond fund that will make that decision for them.
Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent
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