‘Brexit has actually been fantastic for us’
After an incredible run since the financial crisis, bond investors are entering the unknown territory of a “lower for longer” interest rate environment. Bond funds have to work much harder to find suitable holdings, not helped by a drought of suitable bonds in which to invest.
Henderson Strategic Bond, a “total return” bond fund, is often tipped for fixed-income exposure. The £1.7bn portfolio holds 50pc of its assets in investment-grade corporate bonds and 30pc in high-yield corporate bonds, while the remaining 20pc is spread between loans, government bonds, cash and other assets. It currently yields 4.2pc.
Here the managers, Jenna Barnard and John Pattullo, dismiss fears of a rise in inflation and explain why they aren’t “chasing yield” by buying lower-quality investments.
What’s your basic method for choosing investments? JP:
It all boils down to our economic view. We are pretty “deflationist” so want a reasonable amount of interestrate sensitive bonds [which can be expected to gain value if inflation falls].
We don’t like cyclical businesses, such as oil, shipping and airlines, because as far as we can tell they have no pricing power.
We prefer consumer-facing, less cash-intensive businesses such as cable television, health care or beverage firms. We have about a quarter of the portfolio in financial bonds, a mixture of banks and insurance. They tend to be larger companies with a heavy UK bias.
Are you having to take more risk than five or 10 years ago to keep up returns? JP:
As this is a total return bond fund, we’re not slaves to yield. What we try to do is educate our clients that in the current environment yields are going to be lower.
Our high-yield corporate bond weighting is actually at one of the lowest levels we’ve run over the past 10 years. Instead, we have got our yield by buying longer-dated investment-grade bonds.
JB: What happens to the fund if the 3pc or 4pc inflation predictions are correct? JP:
Headline inflation in the UK will rise. But what we learnt from the financial crisis, which fed into inflation between 2009 and 2011, is that most of that gets absorbed in company profit margins, and workers don’t have the wage power to demand that increases in prices be passed through. So inflation will rise and fade, as it did in 2011-13. It’s not something we worry about.
What are you doing to navigate the ‘lower for longer’ environment? JB:
We’ve been buying 10, 20 or 30-year investment-grade corporate bonds, particularly in US dollars, with yields of 4pc-5pc, to lock in yield.
In July we added to floating rate loans to add diversification, but we make asset allocation changes gradually, so post-Brexit there haven’t been any dramatic moves.
We also bought long-dated gilts. Brexit has actually been fantastic, as the Bank of England cut rates and supported the corporate bond market.
There was a currency hit, but we’ve got 45pc of our assets in dollars.
One strategic bond fund has benefited from the Bank of England’s response, its managers tell James Connington
JP: Can investors continue to rely on bond funds? JB:
Clearly the capital gains couldn’t possibly be replicated. Given where valuations are you have to find niche areas of the market.
Legacy banking bonds are one such area. They are being phased out, but essentially in the next crisis regulators want bondholders to bail out the banks, not taxpayers. With these old bonds that doesn’t happen.
We actually think the banks will try to buy them back from us at a premium – more than 10pc of the fund is in them.
Generally, there’s a very low default rate, but any client should only expect the coupon [annual interest]. To make capital gains from here is getting a lot more challenging.
JP: Do you have your own money in the fund?
What would you have done if you hadn’t become fund managers?
I had zero plans. I left university and worked in Tesco stacking shelves. I have no idea what I would have done. I probably would have been an economics teacher.
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