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Snowden: Beware niche alternatives to bond funds

03 June 2013

The manager of Kames Investment Grade Bond says the alternatives to traditional fixed income funds are not worth the extra risk.

By Alex Paget,

Reporter, FE Trustnet

There’s still money to be made from traditional fixed interest funds, according to Stephen Snowden, who says investors looking for better yields elsewhere should be aware of the risks in alternative instruments. ALT_TAG

The stellar run of bonds in recent years has sent yields to historic lows, leading many investors to go down the route of emerging market debt, negative duration, short-dated corporate bonds and floating rate note corporate bonds.

However Snowden (pictured), who runs the Kames Investment Grade Bond fund, says that although fears over a possible "bond bubble" have been over-played, investors who find themselves forcing yield from alternatives are better off leaving the asset class alone all together.

"If you don’t like bonds, don’t buy them," he said.

He adds that many of the alternative bond funds are not only riskier, but often do not yield any more than traditional vehicles anyway.

"There are now a number of alternatives to usual bond funds that are supposedly good for a bear market," he said.

"You’ve got negative-duration bond funds, for example. However, with negative duration that must mean they have negative yields."

"Bond funds with high duration should have a very negative relation to equity markets. So if a fund has negative duration, it must have a positive relation to equity markets. If that’s what you want, then why not buy an equity fund?"

Snowden says it is a similar story for both short-dated and floating-rate bond funds.

"Short-dated bonds do make sense in this environment, except for one thing – what is the point in investing in a bond fund that has a yield of 1 per cent?"

"It comes back to the basic laws of physics in bonds that you have to take interest rate or credit risk to generate a yield."

"There are also floating-rate bond funds. These are a good idea in principle, but the challenge is that there aren’t many of them and they don’t yield much."

"Again, it comes back to the psychology of bond investing that you have to take higher risk to find higher yields."

"Moreover, when you look at these funds they are full of European peripheral debt. That is what angers me the most, as high yield debt isn’t as interest rate sensitive anyway so you might as well buy a high yield fund."

Although he says the idea of investing in emerging market debt is a good one, he believes investors who want exposure to the asset class have now missed the boat as yields have already dropped substantially.

"Emerging market debt has been another popular alternative area," he explained.


"People think I am mad because I say this but yields have collapsed in emerging market debt – it isn’t just gilts that are yielding less these days."

"Yes, those economies are dynamic compared to the West, except for the fact that everyone knows that now."

"Since the central banks have shovelled liquidity into the market, one of the main recipients of quantitative easing has been emerging market debt. I think valuations have now been exhausted."

Snowden has been running bond funds since 2000.

He started his career at Kames Capital, but began running fixed income portfolios at Old Mutual. He returned to Kames in September 2011 and took over as co-manager on the £592.3m Kames Investment Grade Bond fund.


According to FE Analytics, the fund is a top-quartile performer in the IMA Sterling Corporate Bond sector since then, with returns of 22.18 per cent.

Performance of fund vs sector since Sep 2011

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Source: FE Analytics

He has beaten his peer group composite over three, five and 10 years as well.

Kames Investment Grade Bond has a headline yield of 3.18 per cent and is made up of 143 holdings. Its largest credit spread is in BBB bonds, making up 49.46 per cent of the portfolio.

As Kames’ chief investment officer Stephen Jones recently told FE Trustnet, duration remains embedded across the firm’s fixed income range as it has no concerns over a perceived "bond bubble".

Snowden echoes Jones’ thoughts, insisting that the huge amount of debt in the financial system means governments and centrals banks will be forced to keep interest rates lower for longer.

"When you think of a bubble, you should define it as an extreme move in prices that has never been seen before," he said.

"We are not in a bubble; yields have been very low like this before. They are low and there is no doubt about it but the question is – why are yields so low? It is because we have seen a massive deleveraging trend."


"There had been a massive party period before the crash which was carried by a consumption-led economic boom."

"However, structural growth can’t be as high as it has been in the western economies. The simple fact is that we have an ageing economy that needs to pay back excessive debt, so base rates need to stay low for a long time."

"There is also the feeling that the bond market is now irrational, however when looking at implied one-year gilt yields, the market is already pricing in interest rates going up in the future."

"Irrational would mean that people would have given up on interest rates going up all together," he added.

Kames Investment Grade Bond has an ongoing charges figure (OCF) of 1.31 per cent and requires a minimum investment of £500.
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