pa analysis woolnough still in game of thrones

Richard Woolnough at M&G and the two Pauls at Invesco Perpetual (Causer and Read) are about as close as you’ll get to fixed income royalty.

pa analysis woolnough still in game of thrones

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Between them they run billions: Woolnough at the helm of the M&G Corporate Bond Fund (£5.6bn), European Corporate Bond Fund (£2.1bn), Optimal Income Fund (£15.1bn) and Strategic Corporate Bond Fund (£5.2bn).

Suffice to say (in the interests of saving time and space) Causer and Read manage 13 retail funds alone and the Invesco Perpetual Corporate Bond Fund has £5.5bn in assets.

The stock of these three men (no irony intended) has been high in the five years since the financial crisis, as the scale of equity losses shocked the vast majority of investors and risk-averse bond fever took hold.

They have deserved the adulation. Over five years Woolnough’s Corporate Bond Fund has returned investors 50.73%, compared with the sector average of 33.1%, while his Strategic Bond Fund has returned 62.8% over the same period.

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Causer and Read’s Invesco Perpetual Corporate Bond Fund has returned 46% over the same timeframe, putting themselves in the top quartile in the sector. The fund has maintained top quartile performance over the shorter periods of one and three years too, whereas Woolnough’s two funds are second quartile over three years and fourth and third over one year respectively.

As any Game of Thrones fans will know, there comes a time in every King’s reign when his crown is contested. This is often due to external factors outside his control, but it happens nonetheless.

Downgrades

Mick Gilligan, head of research at stockbroker Killik & Co, says the firm has updated its research notes on both M&G’s and Invesco Perpetual’s corporate bond funds, downgrading them from a buy to neutral.

He explains: “Allocation to corporate bond funds within a portfolio continue to provide the benefits of an income yield, ballast (from a reduction in volatility versus other asset classes) and diversification (low correlation to equities). All of these attributes are important in creating a diversified portfolio. The attraction of holding conventional bonds will remain should an environment of stagnant growth, high monetary stimulus and low interest rates persist and the yield spread of corporate bonds over gilts remains at attractive levels given the outlook for defaults.

“However, with base (government) yields at low levels following a period of strong returns over the past five years, the likely trajectory over the medium term is upward. Liquidity is also likely to be a significant issue, especially for large fund managers such as M&G and Invesco Perpetual, should a big rotation out of bonds be experienced.”

The term “Great Rotation” has been bandied around with varying degrees of earnestness since the latter part of 2013.

Apparently coined by Bank of America Merrill Lynch in a research note entitled ‘The Bond Era Ends’ in October, it refers to bond investors rotating cash into equity markets as bond yields inevitably rise in the years ahead.

As with all such theories, there is contention over when this will happen and to what extent. But as investors start to contemplate life after QE and a normalisation of the Federal Reserve’s monetary policy, the arguments for getting out of bonds start to pile up.

Rotation ready

Andy Brunner, investment strategist at Morningstar OBSR, says acceleration in activity in developed countries is expected to drive a gradual recovery in the global economy during the second half of 2013.

“Policy responses by governments and central banks should ensure recovery becomes entrenched and the consensus forecasts a return to above trend global growth through 2014,” he said.

“In the US, 10-year yields have doubled from their lows and many forecasters expect yields to move above 3% during the next six to 12 months,” he added.

All this adds up to a longer-term trend of negative returns in real terms.

This is something, Ignis’ head of credit Chris Bowie is well aware of. In a recent interview with Portfolio Adviser he said a review of pre-QE history showed 10-year gilts with an average real yield of 3%. Currently there are coming in with a real yield of -1.2%.

Any move towards positive territory will be painful, he said, and while he is not expecting them to get back to 3% they might get back to 1% or 2% which would be the equivalent of a 20% to 30% capital loss.

For this reason, Bowie has been recommending his Absolute Return Credit Fund over his Corporate Bond Fund, unless investors are looking for income.

Flexibility first

There’s no doubt bond investors are going to face a host of challenges as central banks navigate towards a post-crisis reality.

Yet some sub-sectors will continue to have their attractions. Shorter duration is well advised and investments in more sophisticated fixed income instruments such as mortgage backed securities could serve investors well.

The truth is a lot of professional investors will be tied by regulators’ ideas of risk into holding some client money in bonds.

So while bond royalty has not yet been overthrown, like the latest generation of the Windsor family it would do well not to show too much resistance to change.

 

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