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Battle of the bonds

John Pattullo’s Henderson strategic bond fund illustrates the wide variety of holdings available to the fixed-interest manager and its performance is testimony to his skill

The low-inflation environment and the increasing numbers of high-yield and investment-grade bonds have meant there have been many more opportunities for investors. But choice brings problems. Do you invest in investment grade, high yield or a combination of the two and what happens if both asset classes are out of favour? Do you try to asset-allocate on behalf of your client or do you just sit on an asset class hoping that the fund manager can minimise losses in the bad times?

The idea that fixed interest is always safe is woolly-headed at best. The volatility of bonds is lower than equities but you can still lose money. In 1994, gilts lost around 20 per cent when the Federal Reserve started to push up interest rates from all-time lows.

It has always seemed to me that much of the industry has not catered for a more managed approach. I would rather leave my bond exposure to an expert fund manager and let him or her seek out the best possible return than merely opt for the highest yield. Protection of capital has to be crucial, otherwise income drops, too.

To be fair, some of the industry has begun to answer this. One of the earliest was John Pattullo of Henderson Global Investors. As director of retail credit at Henderson, he has, in my opinion, virtually single-handedly kept the group’s retail operation from grinding to a complete halt.

I am glad to see that Roger Yates and Phil Jefferson are now getting to grips with the malaise at Henderson and moving it forward. Pattullo undoubtedly deserves a medal.

The basic philosophy behind the strategic bond fund is an unconstrained access to all asset classes. This means it is not tied to any benchmark and, more important, there is no income requirement. This means that returns can be driven from a combination of capital and income rather than the fund manager having to buy a bond just for an income requirement.

You only need to look at what happened to the then Commercial Union income plus fund a few years ago to see what chasing income can do.

Pattullo is able to use loans, including leveraged loans, and preference shares. I suspect it will not be long until he will be able to use credit derivative swaps. In addition, he also looks at the capital structure. After all, it is important to understand where you are in the pecking order if things go wrong.

Within the portfolio, he is able to look at trends and also blend different investments to reduce risk. This is the beauty of a strategic fund. The lack of correlation between some of the fixed-interest investment classes is far greater than one might think. For example, the correlation between gilts and emerging market debt is -0.02 and between high yield and investment grade it is only 0.15. This means that a strategic approach is more likely to bring positive returns through an investment cycle than simply plumping for one asset class within the fixed-interest stable.

Even high yield, which makes up 50 per cent of the fund at present, does not really tell you the full story. A third of this is at the short end of the market with little real high-yield risk, a third is in senior secured floating notes and only the remaining third is in more traditional high yield. Thus, even now, the fund is not in a terribly aggressive position, especially when you consider that cash is near 10 per cent, too. It tends to buy old high-yield bonds rather than new ones, the latter having significantly higher leverage with no equity cushion.

The fund undoubtedly faces more competition now. James Foster at Artemis is probably the chief contender but Pattullo is running neck and neck with Foster over the last year and since the launch of the Artemis fund.

Pattullo strikes me as a canny investor with a deep knowledge of the markets and a great understanding that top down can be important in some years, even if real value added should be bottom up over the longer term. His total return focus and competitive nature in wanting to beat other funds in the sector are all characteristics I like. The fund would make an excellent core holding for any fixed-interest portfolio inside or outside a Sipp.

Mark Dampier is head of research at Hargreaves Lansdown


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