The Case for Managed Income Funds
Whoever thought bonds were boring, think again. After a period of strong performance in the second half of last year, global bond markets have been suprisingly weak so far in 2009. So much so that long-dated US treasuries have lost over 8% this year. In volatile market conditions, how are the Ashburton Fixed Income Funds managed and what are the prospects for the remainder of the year and beyond?
We invested our Managed Income Funds in a very conservative manner in the first few months of this year in the belief that government bonds had become significantly overvalued late last year. Accordingly, holdings were concentrated in short-dated bonds where we saw better risk-return opportunities, given their lower volatility and the likelihood of continued low interest rate policies. We also maintained a bias in favour of European bonds in the belief that European economic data would remain weak and the ECB had further to go in cutting rates.
At the same time, we began to build a holding in highly-rated investment grade corporate bonds which had fallen dramatically in value during the height of the credit crunch and liquidity crisis. The relatively high yields on these bonds offered attractive compensation for risk, in our view. Currently, we hold around 7% in corporate bonds.
In May and June, however, we used the sell-off in bond markets to increase the duration (and yield) of the portfolio by adding longer-dated German and US government bonds. We also built up a 13% weighting in US inflation-linked bonds (TIPS) at around the 20-year maturity, which we believe are attractively valued given the protection they offer against inflation. We also added exposure to Australian bonds, which offer attractive yields. The implied interest rate hikes required to justify current Australian bond yields are too aggressive in our view, offering the potential for capital gain as the required yields on these bonds decline.
But what about the bear case for bonds? This year’s weakness in bond markets is largely explained by (i) improving economic data, (ii) fears over increased supply by governments and (iii) concerns about future inflation. While some concern among bond investors is justified on these fronts, we believe the recent sell-off is overdone (and indeed, recent weeks have seen yields fall quite sharply again as investors come round to this view). The world economy remains fragile, major central banks will maintain low interest rates for some time and until a vigorous economic recovery is underway there is little reason to worry about inflation yet. This explains our recent strategy decisions.
Containing volatility as well as providing a satisfactory total return (income and capital) are very much our priorities when managing the Managed Income and Cash & Fixed Income Funds. Currently the yield to maturity of our Funds is around 3.1% with almost 90% of the Fund invested in AAA-rated bonds. In the context of virtually zero interest rates on cash, we believe this is an attractive proposition.
While a sustained global bull market in government bonds remains unlikely, for the first time this year we have become more positive about prospective returns from bonds on a 6-12 month view, albeit that we are taking advantage of short-term trading opportunities. At current valuations and given the economic backdrop we believe most investors should maintain some exposure to fixed income, especially if they already own a significant portion of riskier assets.
Our Fixed Income Fund range is suitable for a cautious investor prepared to accept only a minimum amount of risk. The Funds are available in US dollar or sterling with the choice of accumulating or distributing class. The Funds aim to generate capital growth over the long term, through investment into an international portfolio of fixed income securities, money market instruments and cash deposits. The Funds are designed to suppress volatility and risk.
