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Strategic points


Henderson’s John Pattullo is a strong advocate of asset allo-cation within fixed-interest funds, as differ-ent types of bond provide vastly disparate returns.

His preference & bond and strategic bond portfolios – co-managed with Jenna Barnard – are both in the strategic bond sector and he expects such flexible mandates to win an increasing portion of inflows from here.

He says: “The current asset split between UK corporate bond and strategic bond funds is around £40bn to £18bn but we see the latter sector as better placed to capture the trend of outsourcing fixed interest. Some of the pure credit funds are higher duration and almost single strategy. If you are buying Tesco yielding 5 per cent against 4 per cent from gilts, most of your risk lies in the latter.”

Pattullo prefers the flexibility to asset allocate on his funds and sees this as the main driver of returns, particularly as sectors such as high yield can be extremely volatile one year to the next.

He says: “High yield can easily be up 40 per cent one year and then down 20 per cent, as can gilts. A more flexible mandate allows us to shift into the most appropriate assets depending on the point in the cycle, taking account of interest rate and default sensitivity. Ideally speaking, you want to be skewed towards gilts and solid investment grade in the bad times and heavier in high yield when things are looking better and default rates are low.”

The team uses credit derivatives and interest rate futures to manage duration and default risk without having to disturb the under-lying assets too much. Pattullo says this is a major reason why the funds got through 2008 without losing money, simply shorting out risks, and expects to do the same to navigate volatility this year.

Overall duration on the portfolio is currently around 1.8 years, with five on the physical assets but three short in gilts using futures.

Pattullo says: “The key theme of the last 12 months has been reflation, with a huge amount of risk shifted from the corporate sector and dumped on taxpayers and governments.

“That is obviously having an impact on government markets but a positive element for credit investors is that default rates have come right down, with the figure estimated to be 2 per cent by the end of the year from 12 per cent in 2009.”

Against this background, Pattullo’s funds are high duration in credit markets and low in sovereign. On the credit front, the team sees little value left in industrial sectors, preferring financials – with bondholders set to benefit from tighter regulation – and crossover names such as ITV.

The latter are between investment-grade and junk and Pattullo also notes companies such as the Daily Mail in this category. Elsewhere, he likes various secured loans, holding 8-9 per cent of both funds in this area, as well as some floating rate notes.

Overall, Pattullo says implied default rates now suggest that credit markets are fair value and they are clearly some way from the incredible cheapness of early last year.

He says: “Credit markets have continued to outperform, explained in part by continued strong inflows into the market and expectations of a rapidly declining default rate.

“We still see certain areas as cheap, including banks, where the opining of the Basel III regulatory committee in December appears broadly positive for bondholders. Regulators are focusing on increasing the quality and amount of capital held by banks, making them less leveraged and more utilitylike – the kind of companies we prefer to lend to.”

On the government market, Pattullo is aggressively short on gilts, believing that you are not being paid to hold them at 4 per cent yields.

He will be reasonably happy if the market sells off slowly through the rest of the year but is concerned about a major blow-up such as in 1994 as that could spread to credit markets.

He says: “There are clear concerns for gilts, with potential for a hung Parliament, supply/demand issues and weak sterling, particularly as a third of this debt is held overseas.

“For our part, we struggle to understand why the Bank of England and monetary policy committee remain so dovish and persist in breaching inflation targets. Our major fear is for a big sell-off and contagion spreading into credit markets although the recent blowups in Dubai and Greece turned out to be good buying opportunities.”


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