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Old Mutual friend

The bond market remains a hot topic in investment circles and I have recently had two very interesting conversations with Stewart Cowley, head of fixed interest at Old Mutual and manager of the Old Mutual global strategic bond fund.

The mandate of this fund enables him to invest just about anywhere when it comes to bonds, such as government bonds, corporate bonds and currencies across the globe. Mr Cowley formerly worked at Newton, where he used to manage significantly more money, but he wanted to make his mark in the more boutique culture at Old Mutual.

One of the biggest debates at present is whether we should be worried about inflation or deflation. If deflation or high inflation take hold, they can seriously cripple an economy. It is generally accepted a low level of inflation is the least worst outcome.

In some countries, there is already deflation and, if we use the RPI index, it is also here in the UK. However, the CPI index (the official measure of inflation) is still showing inflation of 1.8 per cent. Cowley believes the problem is not inflation but that most of the money injected through quantitative easing remains locked up in the system and is not filtering through to the public.

Perhaps his most controversial view is that gilts could have one last hoorah before the seemingly inevitable bear market. He expects the yield on a 10-year gilt could fall to around 2-2.5 per cent. If that happens, in capital terms, you would make around a 20 per cent profit from here. Before you get too carried away, remember this is not a trade for the faint-hearted – at some stage over the next few years, inflation will start to come back into the system and the possibility of the credit-worthiness of the UK or US being downgraded cannot be ruled out.

Bonds, and in particular corporate bonds, have remained hugely popular with private investors, leading many commentators to suggest a few months ago that this was a bubble. At the time, I argued this was nonsense, since for there to be a bubble there has to be a huge overvaluation and this clearly was not the case. Even after this sharp rally, there is still good value to be found but you have to buy more carefully, with stock selection being the key.

One of the biggest calls over the next few years will be neutralising the danger of rising yields. I think many people will struggle to achieve this but one of the beauties of buying into a strategic bond fund is that you can leave it to the fund manager to do the job for you. That is no guarantee of course, but my feeling is that a professional has a better chance of getting it right than most private investors. I can well believe bonds will continue to do well for the time being. Interest rates are not going to go anywhere for at least a year – possibly 18 months – and unemployment will continue to rise for the next two or three years. Taxes will increase next year and he public sector should be cut back. All this is taking money out of consumers’ pockets and, while I can see a recovery, it is going to be a long, slow grind, not a big lurch up.

My conclusion therefore is that corporate bond funds, while unlikely to repeat the last six months in terms of capital growth, are still likely to do better than cash. Some investors may be better off investing in a strategic bond fund that will make that decision for them.

Mark Dampier is head of research at Hargreaves Lansdown

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