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Riding the risk

It was almost a year ago that I featured the Old Mutual corporate bond fund in this column. I thought I would revisit it as performance since then has been uninspiring to say the least.

Over that period, it has fallen by 19.6 per cent against an average fall for its sector of 5.5 per cent. This is despite a very strong rise for the fund since March of around 20 per cent. That is hardly the sort of performance I would have expected from a corporate bond fund, which generally should have relatively low volatility. What went wrong for the fund?

The answer is, in my view, twofold. First, it is fair to say that Stephen Snowden, the fund manager, suffered from being invested in the banking sector and indeed in some of the most economically sensitive companies in the UK at the time of a downturn.

In addition, like many corporate bond managers, he suffered from the severity of the credit crunch when the US government allowed Lehman Brothers to go bust. In fact, it can be argued that this one event exacerbated the credit crunch from a big problem into a full-blown crisis.

For whatever reason, probably political, it seems the US treasury secretary Henry Paulson wanted to be seen to punish one bank and it was Lehman Brothers that came into the firing line. What he had not anticipated was the knock-on effect for the whole of the economic system. Suddenly the holders of bank bonds became very nervous as the government had shown it was prepared to let a major banking institution fail. The result should have been easily predictable – they started to sell their bonds as fast as possible and prices crashed.

Things went from bad to worse in the UK when it briefly seemed as though most of our banks could be nationalised, causing further anxieties for bondholders. Some of the bank bonds fell from their issue price of 100p to around 10p. However, things started to change in late February and early March as the Government injected huge amounts of cash while promising depositors they would not lose their money.

A wave of optimism spread through the corporate bond markets and prices have since been creeping up. From its low point in March, the Old Mutual corporate bond fund has surfed this wave of optimism and made big gains, although it is still some way from recouping its total losses. Mr Snowden has been paring back some of the smaller positions in the fund, particularly in holdings such as Irish Banks, using the opportunity of better liquidity to sell bonds that he judged too risky.

After meeting with him recently I felt he was more confident about the fund and has learnt a lot from last year. He has, for example, broadened out the portfolio to more than 100 holdings in an attempt to add greater diversification and lessen the risk. His view is that we are about a third of the way through a bond market recovery so he has strong conviction that, although there may be some wobbles along the way, if he can make the right calls then the fund will perform significantly better this year.

Unlike many other corporate bond funds, the Old Mutual fund is more sensitive to a company’s credit- worthiness than to movements in interest rates. If Government gilts continue to fall in value, this fund should be less adversely affected than much of its peer group. However, if the economic situation materially worsens again then fears of defaults will re-emerge and the fund could struggle.

In conclusion, I think that within the corporate bond sector this should be considered a higher-risk fund, although this comes with the potential of higher growth too. In the meantime, the income is 10.9 per cent and remember this income is tax-free within an Isa or Sipp. Mr Snowden is much chastened after his experience of last year and I think the fund has every chance to come right now.

Mark Dampier is head of research at Hargreaves Lansdown

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