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Bond strategy changes focus

Hannah Stodell reports on a shift of emphasis

With volatile bond markets expected next year, an increasing number of investors are looking to the strategic bond sector as a flexible solution to ride out the storm.

As interest rates rise, strategic bond funds can scale back exposure to investment-grade credit, increase their position in high-yield bonds and shift up the risk scale to reduce interest rate sensitivity but if rates fall, they can remain in assets which will capitalise on the lower-rate environment. Ucits III powers also enable managers to use long/short strategies for interest rate and credit risk management.

Last week, Money Marketing revealed that Invesco Perpetual is understood to be planning a pure strategic bond fund launch.

Scottish Widows Investment Partnership is also planning a strategic bond fund for new recruit Roger Webb.

IMA figures at the end of September show the strategic bond sector totalled £16bn compared with £43bn for the corporate bond sector and £6bn in the high-yield sector.

Fidelity International chief investment officer Andrew Wells says: “For investors concerned about the impact of rising cash rates, allowing managers more flexibility to extract value from across fixed-income markets may be an important focus for 2010.

“Strategic bond funds may be suitable, including those with the ability to hold an efficient mix of government bonds, investment-grade credit, high yield, international bonds and inflation-linked assets. As interest rates rise, having the right mix of assets may deliver better returns than traditional investment-grade credit funds without unduly adding risk in a portfolio.”

Thames River’s multi-manager duo Gary Potter and Robert Burdett recently reduced their corporate bond exposure and moved further into the strategic bond sector. They say corporate bonds still represent good value but believe opportunities are not as strong as they were.

Potter says: “We want to look past the next six to nine months and the most value appears to be in those portfolios that have a full spectrum to invest in. We want those funds with the flexibility to use Ucits, use govern-ment bonds and tap into high yield. Strategic funds can do all that, so the value is there.”

One of their favoured funds is the £675m Henderson strategic bond fund, managed by John Pattullo and Jenna Barnard.

Pattullo says the fund has seen a pick-up in inflows during November and is taking at least £1m net daily, with £200m already taken this year.

He says: “We would like to think some of that is coming from the investment grade sector but there is still a long- term structural demographic growth into bond funds as people still need income.”

Pattullo says interest rates are the key risk rather than default risk. The fund is steering clear of the gilt market due to the £220bn Government debt issuance planned for 2010 and has a 20 per cent short of gilt futures with extra credit risk held through derivatives.

He says: “We are not that worried about credit risk because high-yield default rates are falling rapidly and businesses are getting refinanced.

“The corporate bond sector is inherently quite sensitive to interest rate risk and the cushion in the corporate bond spread against the underlying gilt market is much less because the spread has rallied so much.

“Our fund is moving into being a high-yield bond fund, you want lots of credit risk and very little or no interest risk whereas this time last year you wanted the opposite.”

Pattullo is pleased about news of new entrants to the sector. He says: “I would hope on a five- year view that the corporate bond market and strategic bond markets would be similar sizes.”

Bestinvest senior investment adviser Adrian Lowcock says the firm is already seeing less interest in corporate bonds.

He says: “We like strategic bond funds and are advising clients to be more in that area rather than the traditional quality corporate end.”

Lowcock stresses it is vital to pick a good manager , saying: “There is always the risk that a manager can get wrong.”

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