Bond building

It was a bond sort of week last week. First, I attended a fixed-interest update with M&G’s Richard Woolnough at the offices of JM Finn & Co. Most interesting it was, too, delivering a fascinating insight into the issues a bond manager has to take into account when shaping a portfolio. Then I chaired one of Cofunds’ quarterly round table discussions, with James Foster of Artemis and Henderson’s John Patullo present. That was a particularly lively debate.

Richard runs a lot of money at M&G – or perhaps I should say the fixed-interest team has several billions under its belt. Perhaps this is partly a func-tion of the difficult conditions that have persisted in equity markets for some time but the reality is that the offerings available from fixed-interest managers have widened greatly over recent years and this vast sector now has much more appeal to retail investors.

Of course, a great deal of money flowed into corporate bond funds in the wake of the Lehman collapse. For those that bit the bullet and invested when all was doom and gloom some two-and-a-half years ago, the rewards have been signif-icant. The big question is, can momentum can be maintained, particularly now that inflation has returned as a threat?

What was clear is that the easy money has been made and that bond managers will find conditions more testing in the future. Not that there was universal agreement between all. Richard Woolnough believes the Bank of England will stay its hand over interest rate rises because of the weak nature of our economic recovery. Both John and James thought the bank had been too slow in reacting to the inflation surge and was effectively in breach of its mandate.

In this regard, they were supported by the OECD later in the week when it pronounced that interest rate rises here could not be deferred indefinitely, even though it revised downwards expectations for economic growth. Against such a background, it seemed difficult to be too enthusiastic over bonds, except that, as they all pointed out, the yield curve was sufficiently steep that it was likely to be the shorter end that bore the brunt of any reaction to dearer money.

From the discussion at Cofunds, the difference between the various styles of management of these funds became apparent. John and James run strategic bond funds. The IMA definition states that, while these funds can from time to time be invested in such a way that they would be eligible for inclusion in a different fixed-interest sector, because the managers retain the right to invest across the whole of the sterling credit risk spectrum, they count as strategic bond funds.

In theory, this flexible approach should give them an edge over other, more constrained mandates but as OBSR’s Gill Hutchison pointed out at the roundtable, even so broadly drawn a definition as strategic bond contained subsets. Some were fully flexible. Others relied more heavily on high-yield bonds. Fortunately, all the managers to whom I spoke believed this represented one of the more attractive areas of the bond market, with declining defaults underpinning their values.

One encouraging aspect of the discussion was that IFAs are better informed about what goes into a bond fund than I had imagined possible.
As to the future, it was clear that all these managers could protect their portfolios against reasonably foreseeable events. It is probably too early to write off this sector.

Brian Tora is an associate with investment managers JM Finn & Co