Low position fails to dent optimism

Stephen Snowden, the manager of Old Mutual Corporate Bond, is sanguine about its position at the bottom of the sector and is optimistic about the opportunities that accompany the volatility.

When a fund falls to rock bottom in the performance tables, the manager usually goes into hiding. Calls from journalists go unanswered. The marketing department goes silent.

But not Stephen Snowden. His £900m Old Mutual Corporate Bond fund is 92nd out of 92 funds in the sterling Corporate Bond sector. It’s also fourth quartile over three years. It doesn’t get a lot worse than that.

I was drawn to Snowden’s fund after a conversation with Jim Leaviss, the M&G retail bond chief. Look down the performance tables, said Leaviss. There has never been such a dispersion of return in bond funds – with M&G and a few others just about keeping in positive territory, while some bond funds are down 20% over a year.

So I looked, and at the bottom is Old Mutual Corporate Bond down 20.4% while the sector is down 8.1%. This isn’t supposed to happen, of course. Retail investors buy corporate bond funds for a smooth, if uneventful, ride. Unfortunately, times are rather too eventful.

Snowden accepts he has made mistakes. “I’m a very heavy personal investor in this fund as well. I’m far from impressed about what I’ve achieved. But remember, the funds doing well now were struggling for many years. Nobody 12 months ago said things would get as bad as the Great Depression.

“I’ve been buying credit too early, because I thought it was cheap. It is cheap. But it has got cheaper. I think we will make good money at some point, but the bear market will last longer than many anticipated.”

Like most managers in the bottom half of the table, he has been too optimistic about banks. They make up 25% of the index, they’re the biggest sector, and how you trade them is the key determinant in any bond manager’s performance.

It’s not that he went wildly overweight into the sector. He never went much above neutral. But the bonds he held were, to put it bluntly, dismal. Look away now if you have been a holder of this fund. It held Northern Rock, Bradford & Bingley and Lehman bonds.

“We were selling Northern Rock aggressively through July 2007 and reduced our position by 40%. But then the market dried up completely.

“We had Lehman’s because we thought that post Bear Stearns, where there was an assisted takeover, that something similar would happen with Lehman.”

On Bradford & Bingley, he’s awaiting clarification from the government but accepts their bonds could be worthless. Oddly enough, Northern Rock bonds have been trending higher, as nervous savers’ cash pours in to a bank with a 100% guarantee. They are trading at about 50p in the pound.

Oh, and Snowden’s other major bank bond holding is RBS. Fingers crossed, then.

Yet he’s not a broken man. Far from it: “You cannot deny that there is a huge amount of volatility, but that provides the long-term opportunities. You only get bargains when people are scared. It would be a complete mistake to have a determined policy to be entirely in or entirely out of the banking sector.”

RBS subordinated bonds are yielding an extraordinary 20%, when a year ago they were at 8%. If you were out of them a year ago, then you made a great call. But today, with yields like that, is it wise to be out? Snowden is not so sure.

Bank equity holders are shot through. Dividends will be slashed, or may disappear altogether. Growth prospects are dismal. But that sort of corrective action is an underlying positive for the bond holders.

Spreads on corporate bonds are trading at levels last seen in the 1930s, says Snowden, so the market is already discounting a dramatic increase in defaults and pricing in an economic depression. If your horizon is one year, then stay in cash, says Snowden. But if you are investing over three-to-five years, then corporate bonds “will make good money”.

He’s also rather bemused at the pricing of his fund compared with others. The dispersion in returns, even after factoring in mistakes such as Lehman and B&B, is wild. What does that tell you? That you need to look as much at the calculation and composition of the figures as much as anything else. The implication is that while his figures may look dreadful, the better figures of other managers might not be quite as attractive as on first sight.

Like every other bond fund manager, Snowden uses iBoxx, a Deutsche Boerse-run product, as his main pricing source. It feeds bond prices second by second from the dealing desks of all the big investment banks. Crudely speaking, it reaches its pricing by cancelling the outliers – the highest and lowest – and then aggregating the rest.

For many years it has worked well. But during the credit crunch, managers such as Snowden have begun to lose confidence. When markets are plunging, the most recent price from an investment bank is the most correct, but it may be cancelled out by the system. Snowden’s worry is that aggregate prices shown may be too high.

Snowden won’t speak about other fund management groups. All he’s concerned about is making sure his fund is priced correctly and all unitholders are treated fairly. Now, for about a third of the trades he is doing, he goes directly to the investment banks to obtain prices rather than rely on iBoxx.

But these are technical issues at a time when markets are going through the most stunning reversal in half a century. “In equity markets, the 1970s were decidedly tricky. And there are still some people who were trading then who are around today. But in terms of credit, this is the worst since the 1920s. And nobody remembers trading in that.” Only time will tell whether the various bail-outs will work.

By the way, when Gordon Brown first took office in 1997, the FTSE was at 4,000. Now it’s 4,000 again. Is that what he meant when he promised us an end to boom and bust?PATRICK COLLINSON The Guardian Personal Finance Editor