The Analyst: Artemis spots bargains amid the panic
Saturday 19 January 2008
Figures from the Investment Management Association suggest that investors have been selling their corporate bond investments. Perhaps they are disillusioned by the funds' relatively poor performance over the last year or so.
However, during that period they were fighting the headwind of rising interest rates. Conditions now look very different, with most people expecting interest-rate cuts of in the region of one percentage point during 2008.
Recently, we have seen corporate bond yields balloon out to levels last seen in the Russian default crisis – close to 1.4 per cent more than government bonds (gilts). Yields are back to where they were around six years ago.
One fund which I think is very much on top of things is the Artemis Strategic Bond Fund, managed by James Foster and Alex Ralph. Mr Foster was on top form when I met him recently. In his view, the cause of the present credit problem was an excess of leverage, resulting from interest rates being left too low for too long. Banks were particularly caught up with this, but are now being forced to bring low-quality assets back on the books because they cannot borrow commercial money.
The upshot is that their balance sheets are being strained; they can't lend money and are running out of cash. What follows this is deflation (or at least lower inflation), which has a dramatic impact on the economy as banks start to offer uncompetitive rates. This is the reason why inter-bank lending rates are so high.
The ultimate consequences of the present problems are obvious. It really doesn't matter what level interest rates fall to if the banks themselves aren't profitable and can't lend money. To see the worst of this you only have to look at Japan, which has interest rates at 0.5 per cent and where for many years banks have not been able to lend money.
However, the central banks in the UK and US are aware of this problem and will be trying to avoid the mistakes made by the Bank of Japan. I am less sure of the European Central Bank, which in my opinion spends far too much time battling inflation and is often the last to move rates down.
So where does all this leave the Artemis Strategic Bond Fund? James Foster expects more defaults in the high-yield space, and this is beginning to be priced into the market. He is still seeing some good bargains and feels he can take advantage of the current panic in financial bonds. He has topped up his positions and now holds 40 per cent of the fund in the financials, giving the fund an attractive yield (after costs) of around 6.1 per cent.
This yield will of course vary, because Mr Foster strives for the best total return and isn't obsessed with yield. I believe that this approach, while giving a fluctuating income, will in the end provide superior returns than a policy that might produce more short-term income, but at the expense of depleting long-term capital.
What I like about the fund is that it is a true managed bond fund. For many clients, it's a superb one-stop shop for your bond portfolio. Most investors don't want to be trading between gilts, high yield and investment grade. So what better than to leave it to a quality outfit like Foster and Ralph?
Mr Foster has always been professionally blunt with his views. When I saw him in 2001-02, he was extremely bearish on equities. What I found interesting this time was that he wasn't entirely negative on equities; in fact, he believes they could make good returns over the next year.
I, like Mr Foster, am not entirely bearish on equities either. Remember that this is a presidential election year in America, which is usually good news for markets. However, I am in no doubt that the overall outlook for 2008 is cloudier than we have seen in recent years. It seems a good idea to have some bond exposure, especially given the likelihood of falling interest rates during 2008.
Most important, that exposure should be via a fund where the manager has maximum flexibility.
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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