Mark Dampier: Nimble Strategic Bonds could be the wise choice

The Analyst

Contrary to many commentators' expectations, gilt prices have gone through the roof this year, and the yield on the 10-year gilt has fallen to a low of less than 2.9 per cent. The financial crisis has made people edgy and trades are being driven by fear rather than greed. According to James Foster, manager of the Artemis Strategic Bond fund, the gilt market is already discounting zero inflation and a double-dip recession. Bond yields have also been driven down by the prospect of more quantitative easing both in the US and the UK. So much so that if extensive QE is not announced when the US Federal Reserve meets on 3 November, I would expect bond markets, and indeed all asset classes, to take a tumble.

James Foster expects interest rates to remain low, probably for six months, but he does anticipate the attitude of central banks will change towards tightening, particularly in the UK where inflation is above target, and he expects an interest rate rise around this time next year. So unless we slip into a period of Japanese-style deflation, the background for government bonds over the next few years could become more challenging.

That is not to say there aren't opportunities in the fixed interest markets. Artemis Strategic Bond Fund yields over 5 per cent, and there are opportunities in bonds that have yet to fully recover from their lows in 2008. Most notably in financials, particularly bank bonds where requirements of the Basel III rules have driven a lot of activity. Essentially the legislation has meant financial institutions are more likely to repay their callable bonds in a shorter time frame, meaning the repayment of capital at an earlier stage for holders. This has caused a strong rally in these stocks and has opened up opportunities to buy other types of bonds as banks refinance. The bottom line is that there are now abundant opportunities in high yielding bank debt for fund managers to pick over.

It is an area in which Mr Foster has had a large part of the portfolio and although he has taken some profits, he still has about 40 per cent in financials. He believes he is being paid a considerable excess over government bonds for what is a lower risk instrument than before.

Ironically, it is the traditionally low risk, lower yielding, bonds that look more risky, even though they are issued by strong companies. The attraction of high yield bonds is they pay a higher income, which could help them provide a return in excess of inflation. In contrast, government and investment grade corporate bonds have lower yields, which can mean they are more vulnerable to movements in inflation and interest rates, and Mr Foster believes they look more fully valued.

For this reason I think it makes sense for investors to turn their attention from investment grade corporate bond funds to strategic bond funds or even high yield funds depending on the desired level of risk. Strategic Bond funds are more nimble and can use a larger range of the fixed interest spectrum, so in the event of a big sell-off in gilts many strategic bond funds have powers to help protect capital. They can use derivatives to short bonds and take cash positions, though this can be at the expense of income.

Meanwhile, high yield bonds are less affected by rising interest rates and instead more correlated with the economic cycle. Provided the economy stays on track, you have more protection in the form of a larger yield. Although this area of the market is the most risky in terms of companies defaulting on their bonds, default rates have been falling sharply in the high yield market. Increased merger and acquisition activity has been good news too. Larger, leaner companies tend to take over smaller ones, which means bond holders in the takeover target suddenly find themselves with a less risky holding as it is backed by a stronger organisation.

So if you are not already invested in strategic bond funds this could be the time to start moving some of your portfolio in this direction, and this fund is one to consider.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

News
newsAnother week, another dress controversy on the internet
Life and Style
Scientist have developed a test which predicts whether you'll live for another ten years
health
Life and Style
Marie had fake ID, in the name of Johanna Koch, after she evaded capture by the Nazis in wartime Berlin
historyOne woman's secret life as a Jew in wartime Berlin
News
news... and what your reaction to the creatures above says about you
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Ashdown Group: Junior Application Support Analyst - Fluent German Speaker

    £25000 - £30000 per annum + benefits: Ashdown Group: A global leader operating...

    Recruitment Genius: Customer Service Advisor

    £15000 - £16000 per annum: Recruitment Genius: A Customer Service Advisor is r...

    Ashdown Group: Trainee Consultant - Surrey / South West London

    £22000 per annum + pension,bonus,career progression: Ashdown Group: An establi...

    SThree: HR Benefits Manager

    £40000 - £50000 per annum + pro rata: SThree: SThree Group have been well esta...

    Day In a Page

    Syrian conflict is the world's first 'climate change war', say scientists, but it won't be the last one

    Climate change key in Syrian conflict

    And it will trigger more war in future
    How I outwitted the Gestapo

    How I outwitted the Gestapo

    My life as a Jew in wartime Berlin
    The nation's favourite animal revealed

    The nation's favourite animal revealed

    Women like cuddly creatures whilst men like creepy-crawlies
    Is this the way to get young people to vote?

    Getting young people to vote

    From #VOTESELFISH to Bite the Ballot
    Poldark star Heida Reed: 'I don't think a single bodice gets ripped'

    Poldark star Heida Reed

    'I don't think a single bodice gets ripped'
    The difference between America and Israel? There isn’t one

    The difference between America and Israel? There isn’t one

    Netanyahu knows he can get away with anything in America, says Robert Fisk
    Families clubbing together to build their own affordable accommodation

    Do It Yourself approach to securing a new house

    Community land trusts marking a new trend for taking the initiative away from developers
    Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

    David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

    The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
    Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

    Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

    Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
    With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

    Money, corruption and drugs

    The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
    America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

    150 years after it was outlawed...

    ... America's first slavery museum is established in Louisiana
    Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

    Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

    The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
    Tony Oursler on exploring our uneasy relationship with technology with his new show

    You won't believe your eyes

    Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
    Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

    Moores must go. He should never have been brought back to fail again

    The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
    War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

    The battle for Mosul will unleash 'a million refugees'

    Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn