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Liquid asset

Gilts in Old Mutual’s bond fund give liquidity and boost growth

Recent Investment Management Association statistics have shown investors to be net sellers of funds over the past few months. This is hardly surprising, given the global economic backdrop and constant flow of poor news, particularly from the eurozone. However, not all news has been negative. In the US, economic statistics have been improving and without the euro zone problems, I think markets would be higher.

One thing that has struck me is that corporate bonds have not followed gilt yields as they marched down to around 2 per cent. In contrast, corporate bonds, or at least corporate bond funds, have yields of around 4 per cent or 5 per cent.

Part of the reason is simply that the Bank of England is buying gilts, not corporate bonds, so there is a natural buyer of gilts. I also believe the market is suspicious of gilt yields at such low levels and investors have been wary because corporate bonds are priced off gilts.

Federal Reserve chairman Ben Bernanke has stated he will not raise US rates until 2013 and it could be argued that the Americans were first into recession, therefore they will be first to raise rates. It seems likely that with rates on hold for some time and with deposit rates so low, corporate bonds look a good bet for those who do not want to take too much risk.

The Old Mutual corporate bond fund is managed by Christine Johnson, who joined Old Mutual in September 2010. She took over this fund when Stephen Snowdon left for Kames Capital in April 2011. Since taking over, she has purged the fund of illiquid and “event-driven” bonds (those reliant on a specific economic outcome).

She was understandably keen to have a very liquid portfolio, allowing her to adjust holdings as markets changed. Many investors think the corporate bond market is as liquid as gilts but nothing could be further from the truth.

It is highly illiquid, which makes making dramatic changes difficult. She is aided by the size of the fund though. At £520m, it is tiny compared with many peers.
Johnson is one of the few fund managers who has had a reasonable holding in gilts over the past few months. This gives her liquidity but has also boosted growth as gilts have prospered.

She also holds around 30 per cent in AAA-rated bonds, with maturities averaging about eight years. After charges, the fund yields about 4.4 per cent, double what a 10-year gilt yields. Bear in mind that in a Sipp or Isa, this is also tax-free.

Overall, the fund is defensively positioned, with no exposure to peripheral Europe. Johnson is also building some US exposure where, as I said, the economy is showing signs of improvement. She also wants to be able to respond to any change in situation which is why there is such a strong liquidity theme running through the fund.

While I believe gilt yields at 2 per cent offer little value, this is of no great consequence if the Bank of England, pension funds and banks continue to buy gilts. It is therefore quite likely gilt yields will fall and stay below 2 per cent in the near future.

Consequently, I think there is every chance corporate bond spreads could tighten against gilts, giving some capital increase in bond values as well as locking in yields of over 4 per cent. I believe this is well worth considering for more risk-averse clients.

Mark Dampier is head of research at Hargreaves Lansdown



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