Hodges (pictured) is wary of the high levels of macro uncertainty, and says he is using the unconstrained and global nature of his £1.7bn L&G Dynamic Bond fund to protect his investors.The manager adds that too many of his peers are taking on too much risk in their funds and will inevitably be caught out when market volatility kicks in.
"I’ve told everyone that I have met since the launch of the fund in 2007 that I am not investing 100 per cent upside in any asset class," he said.
"It is a fallacy to think that even the most respected managers can do so without taking too much risk as it is impossible for anyone to time turning points in asset classes."
"I look at a maximum of 70 to 75 per cent of upside risk, to ensure there is a level of downside protection."
The fund currently has a yield of 4.8 per cent, which Hodges says is lower than usual because he is using some of the income to manage volatility.
"The fund usually has a yield of anywhere between 4.8 per cent up to 5.4 per cent, which is a greater level of income than investment-grade bond funds," he explained.
"Today, there are uncertainties around geo-political issues and peripheral growth so I am spending a little bit of that income to protect on the downside."
"That’s not to say that the fund won’t be up to above 5 per cent yield in a month’s time, but at the moment I am willing to give up income and capital growth to immunise volatility."
"The high yield sector is distributing about 6 to 6.5 per cent and anything above that level means that the risk those funds are taking is unpalatable at the moment – it is just wrong as it is too great a level of risk."
"High yield returned 20 to 25 per cent last year. Investors are surely mistaken to think that can be repeated. I think we would even be unlikely to see double-digit returns," he added.
Hodges has managed L&G Dynamic Bond since its launch in April 2007.
According to FE Analytics, it is the best-performing IMA Sterling Strategic Bond fund over five years, with returns of 75.46 per cent, beating its sector average by 36.79 percentage points in the process.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The fund currently has around 30 per cent in high yield, with 10 per cent of that in the L&G High Income fund. Hodges also has exposure to European sovereign and corporate bonds and has the ability to take short positions.
The manager says he is being particularly vigilant when looking at bond duration, because he feels a lot of investors will be caught out when interest rates and government bonds yields inevitably increase.
"One of the areas of the market we like is bank debt – 28 per cent of the fund is in banks, which may seem a lot, but the Sterling Corporate Bond sector is benchmarked at 45 per cent."
"It doesn’t seem that much to me and out of that 28 per cent 15 per cent of those bonds will mature before the end of 2015."
"This is because I am expecting interest rates will rise around 2015 to 2016, and with 15 per cent of the fund maturing in the next two and half years it means I will be able to reinvest at higher levels of yield."
"Interest rates are already at very low levels and they could go even lower and be negative – like in Germany – but they wouldn’t go much further."
"If I am right, we will reinvest the proceeds, however sterling corporate bond funds have a duration constraint of two years either side of seven years."
"I get asked the questions: what happens when this fixed income bubble comes to an end? What happens to liquidity when interest rates do rise?"
"At that stage, managers are just going to be hoping that they are cleverer than others and sell out before the rest."
"That is a fallacy – it is just a joke to have that mind-set. You have to have the ability to still generate returns when that happens and that’s why over the next two and half years, 15 per cent of the fund’s bonds would have matured."
He thinks the biggest danger to the fixed income market is when returns do not reach investor’s expectations, and although it won’t happen yet, he believes this could spur on the so-called "great rotation" in to equities.
"There are net outflows in the corporate bond market now," he said. "However, it hasn’t had an effect yet as they’ve been immaterial compared with the amount of money in corporate bonds in the first place."
"I’m not naïve enough to say it isn’t going to happen to my fund either. Investors will hear about the rise in rates and will want to get out of fixed income, and I will be sad to see it. But my opinion is that this fund is the last fund a fixed income investor should sell out of."
L&G Dynamic Bond has an ongoing charges fee (OCF) of 1.42 per cent and requires a minimum investment of £500.