Bond strategies for a ‘very boring’ world

Q: What changes are you making to the fund? A: I was pleased to see there was nothing in there that worried me. When most fund managers take over running a fund, they see a couple of names and question what they are doing in the portfolio. But the fund is already set up in anticipation of a positive year for credit, which is a view I agree with. However, I am somewhat more bullish so I am going to be moving it a bit further down the line. You want to be exposed to credit risk. This could mean going further down the credit ratings. Another point to make is that the fund is short-duration. I also believe a short duration is the right position to adopt, but will be moving it a bit shorter. A healthy economy means interest rates are more likely to rise. Furthermore, it is going to be a difficult year for gilts because supply is going to be high, and as a consequence prices will come down. I am very concerned about the level of the yield curve. Is it going to be a massive sell-off? I don’t think so, but pressure is going to be on the downside. Q: Will you be altering the investment process? A: No. The way the fund is run is as a concentrated portfolio. I also ran a concentrated portfolio at Aegon. Q: When will you have finished reorganising the portfolio? A: I have already started shortening the duration and increased the credit sensitivity of the portfolio. But there is not a lot to do to reflect these views. However, I will always be changing the portfolio, so in that sense it will never be reorganised. Q: How do you feel working under Sofia Skalistiri, head of fixed interest at Old Mutual Fund Managers, after coming from being head of retail fixed income at Aegon Asset Management? A: I still worked under several layers of management at Aegon and, in fact, am now working under fewer layers. It is a flatter structure than I am used to. Q: I understand Old Mutual’s team and resources are less than Aegon’s. Will you have enough support? A: It is important to remember that Old Mutual is a very focused business. Because of this they do not need the same number of staff. Companies that do many things for many people need more employees. Q: Which sections of the bond market do you like the most at present? A: If you look over the past four to five years, the credit market has been very volatile. Spreads have widened and tightened and then widened again, but this decade is going to be like the 1990s when you had long periods of stability. In 2002 a bond manager just had to be defensive. In 2003 he needed to be aggressive, but this year will all be about stock selection. Within each sector there are going to be winners and losers. Trading on volatility within individual stocks will be the way to make money in the coming 12 months. However, I have always been keen on the banking sector. These bonds are trading cheaply, while the financial system is very robust. Q: Are you going to skew the fund to any particular grade of bond? A: I will have very little in AAA-rated paper. The fund will be more positioned towards A and BBB-rated paper. In my current view it is going to be a positive year for corporate bonds and not a bad year for equities either. If 2004 does turn out as I expect, there will be a modest compression of corporate bond spreads. In a positive economic environment, spreads on BBB bonds will compress much more than those on the AAA issues. Q: Are you going to continue investing in the same areas of the market as the previous manager? A: The last manager tended not to invest in non-rated stock, which is something I am keen to explore. It is an unloved area of the market. People will not touch these bonds just because they are non-rated. But some were secured with property in 1990. We all know that 1990 was bust time for the property market. Even if there was a sustained fall in property prices in the UK, they are still going to be higher than the levels they bottomed out at in 1990. Some of the non-rated bonds are trading on high spreads but are safer than UK government paper. Q: The fund has no high-yield paper at present. Are you going to change this? A: The nature of the sector the fund is in, the IMA’s UK Corporate Bond category, means I have to have at least 80% of the portfolio in investment-grade paper. But if you believe it is going to be a stable year, then you want to be increasing the credit risk in the portfolio. I am going to use the flexibility the portfolio gives me but it is unlikely I will use the full 20% I have free to put into high-yield paper. But I could opt for 10% high-yield some time in the next few months. Q: Are you not concerned about capital losses since prices have come so far in the past year? A: The last 12 months have been great for high-yield paper. The danger is that high-yield does not live up to investors’ expectations this year – which, in my opinion, is going to happen. However, having said that, it is not going to be a poor-performing sector. Q: What kind of returns are you hoping to achieve? A: We are always going to be a single-digit type of return. I would try to get something in the range of 6-8% a year. Q: What is your outlook for the economy? Will an improving outlook be bad for bonds? A: There are scare stories in the news that the consumer is more indebted than he has ever been in the past, but I do not believe there is any impending doom for the economy. In the future the world is going to be very boring. The days of boom and bust are over and we will tick along with a moderate level of growth. You have to be active and nimble and trade on what little volatility there will be. You won’t be able to pitch your tent on one side of the risk river and camp there for a whole year. Because of this, the difference between the best and worst-performing funds will be less than in 2003. There have been two opportunities to get it wrong in the past two years, by either being far too aggressively positioned when you should have been defensive or overly defensive when an aggressive stance was correct. Q: Why did you become a fund manager? A: When I was at university I knew I wanted to do something financial. I applied to all manner of different jobs and I was lucky to get one in fund management. Within a couple of days doing the work I realised I had made the right move. Quite simply, I really enjoy it. I like the competitive element.