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The bond plays on

Demand for corporate bonds is so strong that companies are able to favour the stock holders over bond holders at present, says DWS UK corporate bond fund and corporate bond plus fund manager Anthony Fletcher.

He says that demand is most evident in the high-yield market and among some of the lower-quality BBB-rated investment- grade names.

“Companies are more willing to use their balance sheet muscle to grow profits for the shareholders and if that is at the detriment of the bondholders, they do not seem to be too concerned about it at the moment. It is not surprising really when you think about the demand and supply situation in the corporate bond market,” he says.

Fletcher describes his investment style as a top-down approach majoring on macro asset-allocation decisions. Two areas which he says add most value to the portfolios are interest rate risk and the yield curve but stock selection has become increasingly important over the last few years, he adds.

Now owned by Aberdeen Asset Management, the 63m DWS corporate bond plus fund is ranked 11th out of 75 over three years to October 24 in the UK corporate bond sector. It posted a return of 22.5 per cent against a sector mean of 18.2 per cent for the same period but the fund has not delivered such good performance over one year, dropping to 63rd out of 92 funds and posting a below sector average return of 5.3 per cent.

Fletcher explains that although he does not like to see a lot of volatility in the short-term rankings, he says it has been a by-product of positioning for the medium to long term.

He says: “Our objective for both of these funds is to be in the top quartile of the Investment Management Association’s UK corporate bond universe over a period of a couple of years or so and to try and maintain that ranking but that does not mean to say that we may not have short-term periods of volatility.”

The funds have recently used the 20 per cent flexibility to invest in non-UK bonds, taking an active position in Mexico, Poland and longer-dated European issuance. Fletcher says: “We have felt for some time that the technical as well as the fundamental dynamics for long-dated bonds in Europe have been more attractive than they have been in the UK so that is an example of an asset-allocation decision.”

He remains nervous of the high-yield market and thinks that it is an opportunity which is “past its sell-by date”. It is looking too expensive, in his view, due to yield compression.

He is particularly pleased with the way that his team has managed its position in General Motors, GMAC and Ford. He recognised there were difficulties in these securities early on and the portfolios sold out of them before they were down-graded to sub-investment grade.

On the macro side, Fletcher thinks the inflation risks are higher than they were six to 12 months ago. “We are becoming increasingly concerned about inflation and it is working its way up in terms of things we feel we need to watch more closely,” he adds.

The DWS corporate bond fund launched in March 2004, two and a half years after the main fund was launched. It is differentiated from its sister fund by using the currency market to add value and is investing predominantly in US corporate bonds hedged back into sterling. The performance of the 18m fund has suffered recently, dropping from a one-year ranking of third to a three-month ranking of 80th.

Fletcher says: “The corporate bond fund tries to take advantage of the global markets so in periods where UK markets are outperforming, as they have done lately, this fund will not do quite as well. Now we have had short-term outperformance of the UK relative to the rest of the world in corporate bonds and government bonds and that is the principal reason for the shift in the ranking between three months and one year.”

Another reason the fund has suffered, according to Fletcher, is its currency position. He says: “We have not been getting our major currencies right but we have been getting our minor currencies right.”

At present, he says he does not have any specific yield curve views but wants his portfolios to be underweight to interest rate exposure to ensure they have less rate risk than their benchmarks.

In the medium term, Fletcher thinks there are more opportunities globally than in the UK and he believes interest rates will continue to rise in the US and potentially in Europe within the next six months.

He also thinks it is a possibility that rates may rise in Japan for the first time in years.

He says: “The market is still pricing in a cut from the Bank of England. We do not believe they are going to cut rates so our general view is that interest rates are going to go up and bond yields should therefore go up.

“We are also of the opinion that, at the aggregate level, whether you look at emerging debts, high yield, or investment-grade credit, the spreads are a little bit on the expensive side. They are not as cheap as they were so you have got to be cautious.


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