Old mutual takes equity approach to bonds

Q: You and Andrew Tunks co-manage the Dynamic Bond fund. Why does the fund need two managers?


I joined Old Mutual from Morley initially to work with Stephen Snowden on the Omam Corporate Bond fund. However, as the stockpicking process used on the two funds is complementary, it meant I was spending a lot of time on the Dynamic fund.

There is a big overlap of holdings between the two funds. At present, 30% of the holdings in the Dynamic Bond fund are also held in the Corporate Bond fund. As a result my move to co-manager of the Dynamic fund was more just crystallising what I was already doing.

Q: How do you and Tunks divide responsibilities on the portfolio?


On a day-to-day basis my responsibility is the stockpicking aspect. Andrew’s input is more on the asset allocation and strategic calls that the fund makes. So he works on the top-down side of the fund and my job is the bottom-up element.

Q: Has the portfolio seen any major changes since your appointment as co-manager?


As my input into the fund really began in June last year there have been no large changes since my formal appointment as co-manager.

Q: Over the the past 12 months the fund has returned more than 7%, which is about 1% ahead of the peer group (IMA UK Other Bond) average return. How have you achieved this?


Mainly through good stockpicking. Not a lot has gone wrong with the stocks we have chosen this year. We have benefited from some buy-backs, positions in debenture stocks and positions in UK housing/care homes. The only one position we got wrong was an American healthcare company called HCA. Good asset allocation over the year has also helped. On the high-yield side, HCA aside, our holdings in a number of South African companies have done well for us.

Reclamation, a steel recycling company, and FoodCorp, South Africa’s version of Heinz, have both performed well as the South African economy has also done well.

Q: Where have you been investing in the bond market?


At the start of the 2006 the fund was overweight in high-yield bonds and underweight in investment-grade bonds. We reversed this position in the second half of the year to be underweight high-yield and overweight investment-grade. The fund is run to be 50% weighted in the two asset classes, so we started the year 60% invested in high-yield and 40% investment-grade, which includes non-rated bonds.

Q: Why did you switch asset classes in the middle of the year?


High-yield has had a good 2006 and as a result valuations have risen. Meanwhile, investment-grade bonds had a poor first half to the year, mainly because of the rises in interest rates. No one predicted they would rise by 2%. Gilts also had a poor first half of the year. As a result we think investmentgrade is set to perform better both now and going into the first quarter of 2007.

It is mine and Stephen’s [Snowden] view that the last quarter of the year is a robust one for the UK market. UK gilts have not delivered a negative return during the fourth quarter for more than 20 years, and neither have corporate bonds since records began in 1991. This is because there is a lot of cash to invest during this period.

December 7 is the biggest coupon payment day during the whole year. Not only do many gilts pay their coupons on that day but so do many corporate bonds. They therefore have a lot of cash to reinvest, which helps to drive prices higher. In addition to this, many bonds redeem on the same day.

Q: How much of the fund is invested in non-rated bonds?


At present 19% of the portfolio is held in non-rated bonds. Under IMA restrictions, in the Corporate Bond sector you can only have a maximum 20% invested in high-yield and non-rated bonds. This fund is placed in the UK Other Bond sector, which dictates we have to have a minimum 20% in high-yield, so we have more freedom.

A lot of this year’s performance has come from holding non-rated bonds, all of which are the debenture stocks we own.

Q: Are you an active user of cash?


We tend to be fully invested most of the time. We get paid to manage a bond fund, not sit on 20% cash.

Q: How many holdings do you have in the fund and how high is turnover?


This is very much a stockpicking fund, meaning all the names we hold in the portfolio are names we really like. There are no holds or neutral positions. At present there are 65 holdings in the fund. As a result, for a fund of this nature, turnover is high. Over the year to date it has been 250%.

This is because it is actively managed and looks to exploit changes in valuations on a daily basis. However, turnover on this fund is not as high as it is on the Corporate Bond fund, which is closer to 400%. This is because it is more expensive to turn over high-yield bonds than it is investment-grade bonds.

Q: How would you describe your investment approach?


It is not about picking good companies; it is about picking good stocks. The bond market is very different to the equity market. It is unique because every bond issue is different, and we look to exploit these differences. Basically, we take an equity approach for investing into the bond market. It is all about stockpicking rather than big macro calls, such as which way we think interest rates are heading.

Q: What are your predictions for 2007?


We think it will be another good year for high-yield bonds. While we have reduced our weighting in the asset class on valuation grounds, it is difficult to see it doing badly.

While it will struggle to repeat the performance of last year, a backdrop of strong global growth next year and low default rates will see it perform well. Indeed, European high-yield default rates have been zero for the past six months.

This year has not been a great year for investment-grade. Indeed, if you get a positive return from the asset class you will have done well. However, we think it has the potential to do better in 2007, which is the reason we are now overweight in it.


joined Old Mutual Asset Managers in June 2005 from Morley Fund Management. He was appointed co-manager of the Dynamic Bond fund in May 2006, working with Andrew Tunks, head of fixed interest. At Morley Higham was a credit researcher covering both high-yield and investment grade-bonds. He specialised in the technology, media, telecommunications and consumer sectors. Higham joined Morley in 1999 as a graduate trainee in the gilts department and switched to the credit team after three months.