Artemis fixed income manager James Foster’s career has been closely correlated to the rise of the retail bond fund sector, despite him initially “aspiring to the world of equities” as a graduate.
Foster began his career at Sun Alliance (subsequently Royal Sun Alliance) as a trainee bond analyst. Joking that he “probably didn’t know what a bond was at that stage,” Foster says he realised he enjoyed fixed income and went on to launch one of the first retail corporate bond funds when Ken Clarke, then Chancellor of the Exchequer, gave the go ahead for PEPs to invest in corporate bonds in 1995.
Having immersed himself in the fixed income world Foster soon saw his assets under management soar. Sun Alliance merged with Royal Insurance and the corporate bond book was split off and left in Foster’s hands.
With interest rates falling 1 percentage point between 1995 and 1996 to 5.75 per cent, investors were searching for income and government bonds were sold in favour of corporate bonds, meaning Foster found himself managing £6bn in the space of a couple of years.
“I was everyone’s best friend,” Foster laughs. “The training [in that environment] was as good as I was going to get anywhere. I started to learn that these things tend not to go bust, so I was buying bonds when everyone was scared of them. A strong franchise can generally pay the bonds. It was a nascent market and the high-yield market didn’t really exist.”
Royal Sun Alliance was then merged with Friends Ivory and Sime to form ISIS Asset Management in 2002, with the latter subsequently merging with F&C Asset Management in 2004. It was at this time that Foster decided to part ways with the firm.
“I didn’t want to do another merger, it was too much like hard work,” Foster says. “It was amicable, I had spent 15 years there. It was the natural time to move on.”
With an element of consonance, Foster wrote to Artemis co-founder Mark Tyndall to suggest launching a bond franchise at the same time Tyndall had written to Foster suggesting the same. At the time Artemis only had the High Income fund, run by Adrian Frost.
In 2005 Foster joined Artemis with Alex Ralph, who worked with Foster at ISIS. The same year they launched the first Strategic Bond fund.
“Artemis wanted to boost their bond profile,” Foster says. “They had started with funds generating income, as that’s what their clients wanted, but the clients were also concerned with the downside risk so it seemed appropriate to launch a strategic style fund.
“I think we were the founder of strategic bond funds. We were very much first in the whole evolution. It is nice to know the sector is named after us.”
In 2012 Foster and Jacob de Tusch-Lee launched the Monthly Distribution fund, which has just marked its all-important three-year milestone and was recently awarded a Bronze rating by Morningstar.
“The aim of the fund is to generate income, it is its raison d’être,” Foster says.
The fund is currently yielding around 4 per cent, but Foster adds that there is no income target “as you can be hoisted by your own petard”.
“I have seen funds have to chase worse companies for the yield,” he says. “There is a tightrope between income that is too safe and income that is too risky.”
The management of the £51m Monthly Distribution fund is divided between Foster and de Tusch-Lee with a 60:40 split. Foster focuses on sterling and European high-yield debt while de Tusch-Lee’s remit is global equities.
“We started with the sub sectors of two funds and the fund developed a persona in its own right. It is a one-stop-shop for investors.”
“The bond side tends to be more focused on Europe and the UK as we think there are enough alternatives there,” Foster explains. “We hedge out the currency risk in the bond component, as we know we have got a fixed coupon payment coming in the future. In equity land they might have hedged already so we don’t hedge.
“We sit close together and have a pretty steady dialogue,” Foster continues. “We speak a lot to make sure we don’t double up. There is a whole gamut of things, a range of assets we look at to see what can generate the best income for clients. At the moment the fund has 19 per cent in hybrids.”
Foster’s portfolio mirrors the Strategic Bond fund while de Tusch-Lee’s holdings are a subset of his Global Income fund. There are a total of 175 positions of between 0.5 to 1 per cent that Foster describes as “deliberately fairly broad”.
“We are not trying to have stock risk as that adds to volatility,” he says. “It is bad fund manager practice to over concentrate portfolios.”
The fund’s turnover is, Foster says, “reasonably high” at 158 per cent for the past year, although he says de Tusch-Lee is “more of a turnover merchant as the cost of dealing is higher with bonds”.
Over the year to 16 July the Monthly Distribution fund is up 7.5 per cent against the 5.5 per cent of the IA Mixed Investment 20%-60% Shares, FE data shows, although Foster says: “I don’t like to dwell on these things”.
The fund’s allocation to high yield (around 40 per cent) has aided performance, with “not too many blow-ups”. Among the high-yield positions, Foster added to oil stocks at the start of the year, “when everyone hated them.”
An allocation to cinema group Odeon has also benefitted performance. “Odeon has done very well,” Foster says. “Everyone worried about the film slate last year, but this year the big films are coming thick and fast, or should I say Fast and Furious!”
More recently hybrids have not performed so well, which Foster says “probably affected performance,” due to fears over changes to their tax treatment in the Summer Budget. Currently 50 per cent of a hybrid security is treated as an equity (and the remainder as a bond), but this could be perceived as tax avoidance by HMRC leading to a change in tax legislation.
“We don’t think the change will happen without grandfathering existing deals,” Foster says. “But that would be financial engineering at its worst. We think if it does happen the government will allow convertible bonds to continue with their existing treatment.
“It was too technical to be announced in the Summer Budget but tax avoidance is generally treated with disdain by the Treasury, quite rightly.”
With hybrids falling in value, Foster used the opportunity to increase the fund’s exposure to the securities, taking the allocation from 17 per cent to 20 per cent.
Meanwhile Foster has been cutting the fund’s exposure to investment grade bonds in anticipation of interest rates rising, reducing it from 25 per cent a year ago to 14 per cent now.
“We don’t top up the investment grade bonds and we have an active flow of money, so the smaller holdings are diluting,” Foster says.
“The US will increase rates in September, and that will be the driver of everything else. The UK generally follows six to nine months later. The Summer Budget wasn’t as tough as some expected, so the UK could raise rates in May 2016.”
1989: Foster begins his career at Sun Alliance
2005: Foster joins Artemis and launches Strategic Bond fund
2012: Foster and Jacob de Tusch-Lee launch the Monthly Distribution fund