While several bond managers argue short duration is the safest place to be, Stephen Snowden, the manager of the Old Mutual Corporate Bond fund, is happy holding long-dated government bonds.
In 2008 Snowden’s performance suffered owing to his high credit exposure and his position in financials. However, rather than crystallise his losses by changing tack, the manager kept faith with this strategy and has been well rewarded year-to-date.
According to Morningstar, from the start of the year to September 28, the fund returned 30.34%, versus the IMA £ Corporate Bond average return of 12.82%. This ranked the £737m funds first out of 85 funds in the peer group.
“The last few months have been an unusual period,” says Snowden. “Credit spreads have rallied as well as long-dated government bonds. Our allocation is towards long-dated US treasuries and German bunds and we suspect our duration profile is longer than the peer group.”
Snowden says he has sympathy with the short duration argument, but he says government bond markets continue to rise higher, which he says has aided the fund’s performance.
“The budget deficit and the gilt issuance that will come on the back of this is a concern,” says Snowden, “so I have sympathy with those that have concerns about gilt yields and their potential to increase. It is clearly a risk to corporate bond investors.”
The risk, however, for those who have gone short duration, says Snowden, is that the Bank of England continue the programme of quantitative easing, which so far this year has absorbed a lot of the gilt supply.
He says: “The market thinks that £175 billion is the facility, but the risk to being short is that this facility is extended. We don’t love gilts and an extension in quant easing isn’t central to our scenario, but if the threat of inflation seems distant, which we think it does, then government bonds look an attractive place to be. It is easy to pour scorn on the asset class, but there are two sides to every argument.”
While Snowden does not expect future returns to match those made so far this year, he still expects credit and equities to outperform cash in 2010.
“The once in a lifetime opportunity has gone, but credit spreads remain elevated and are now at a once in a decade level, so it remains cheap historically,” he says.