‘We had no Russian bonds but China has hit us’

Bond buyers face a tricky time as central banks raise rates, but TwentyFour manager Gary Kirk has some workarounds. By Danielle Levy

Bond markets have been anything but boring since the start of the year. Investors have had to digest the implications of the Russia-Ukraine conflict while managing higher inflation and rising interest rates – a toxic cocktail for debt.

Until the invasion of Ukraine on Feb 24, demand for government bonds this year had been weak. Prices fell and yields rose ( the two move inversely to each other). This was down to high inflation, which is generally bad for bonds because it erodes the “fixed income” they pay over time.

Then the war started and investors flocked to “safe haven” government bonds. This caused prices to rise and yields to fall – although the trend proved short- lived. As it became apparent that energy prices would remain higher for longer, feeding through to already high inflation, yields have risen since early March.

Fund manager Gary Kirk acknowledges that bond investors face a challenging time, but says there are still opportunities to make money. His £ 1.7bn TwentyFour Dynamic Bond fund, a Telegraph 25 favourite that he runs alongside three others, has returned 17pc over five years, against 13pc from peers, and yields 4.7pc.

Mr Kirk tells Telegraph Money which bonds will make money this year and why he doesn’t believe other economists’ predictions that the Bank of England will raise interest rates five more times this year.

WHAT IS YOUR INVESTMENT STRATEGY? We want to generate a consistent level of income regardless of how economies are performing. This is an income fund first and foremost, and we are flexible about what types of bond we buy.

We manage the three risks associated with bonds independently: interest rate risk, which refers to potential losses from rising interest rates; credit risk (the potential for the borrower to default); and market risk (volatility). At the same time, we aim to take advantage of markets valuing bonds for less than they are worth.

HOW CAN INVESTORS PROTECT AGAINST INFLATION? Higher inflation means higher interest rates. Meanwhile, the dreadful conflict in Ukraine has created a commodity price shock, adding to already high inflation. This is something investors are right to be wary of, because inflation erodes wealth.

Fortunately, there are a few things you can do. One is to avoid government bonds, particularly ones that will mature far into the future. These are more sensitive to rate increases. This poses a conundrum when events spark a “flight to safety”, which pushes up the value of government bonds. But we still prefer to avoid any that are far from maturity.

Investors are very cautious right now and this creates volatility in bond prices. One way to mitigate this is to invest in corporate bonds that will mature in the next three years. These are less sensitive to interest rate moves.

Here, we focus on “high-yield bonds”, where we are willing to take on slightly more credit risk because the default rate, which measures how many companies default, is very low. These bonds also offer an attractive yield for the risk.

We also have an “interest rate swap”, which reduces the portfolio’s sensitivity to rate rises. This is a contract where another party agrees to exchange a variable interest rate for a fixed rate. When interest rates go up, we make a profit.

HOW MANY TIMES WILL THE BANK OF ENGLAND RAISE RATES THIS YEAR? The expectation of another five rises is too high, given the impact of the Ukraine conflict. I suspect the Bank will raise rates again some time before July. We will get to 1pc and then the Bank will pause to see what the impact is on the overall economy. We have National Insurance contributions going up, higher energy costs, plus higher interest rates, which affect mortgage repayments. This is going to have an impact on consumers. The last thing the Bank wants is to choke the economy by putting rates up too quickly.

WHAT HAS BEEN YOUR BEST INVESTMENT? Our bank bonds have generated the best returns over the past three years. Banks have come through the Covid crisis unscathed and they are in far ruder health than they have ever been. The regulator’s curb on divi dend distributions for the 18 months to October 2021 was a big help for bond investors, as they didn’t distribute this cash and kept it on their balance sheets. Today, the yields on offer still look attractive versus other industries.

AND YOUR WORST? Over the past six months, our small exposure to the Chinese bond market has been painful. We have virtually sold out now. Fortunately, we had no exposure to Russia.