In recent weeks the Fed "dropped a bombshell" by saying that it may slow its bond-purchasing programme, causing huge volatility in global equity and bond markets. This has caused many experts, such as Darwin’s David Jane, to fear an all-out crash in fixed income assets. However Spreadbury (pictured), manager of the £1.4bn Fidelity Strategic Bond fund, is unconvinced.
The manager says he is positioning his portfolio for a period of more central bank stimulus, as he thinks it is clear that the economy is no-way near ready to function without such a strategy.
"I suppose at some stage QE has to end. But I think the problem is that the recent market turmoil has underlined that markets are hooked on money printing," he said.
"In my opinion it is not going to end any time soon. My base-case scenario is that QE continues with benign inflation, and our treasury model – based on that scenario – indicates that yields will stay low or go even lower."
"I think it is very difficult to exit from QE; ultimately, the markets have demonstrated in the last few weeks that any sniff of tapering or reduction of QE has led to some reasonable hikes in rates. Certainly on a two-year view there is an 80 per cent chance of QE continuing or even increasing."
"For QE to stop, we do need to have a much more convincing pickup in growth," he added.
Spreadbury says reduced quantitative easing would have a huge impact on developed government bond yields, which is further evidence of why the tap will not be turned off.
"The alternative scenario is that QE stops from next year, with the assumption that the Fed’s treasury holdings remain constant," he said. "We estimate that that would cause yields to rise to 3 per cent. Clearly, any reversal or stopping of QE would have an impact on bond yields."
"The problem with that is that would feed through to the economy very quickly, so I think it is a pretty unlikely scenario."
"The third scenario is that QE is reversed in 2014, with the Fed’s holding in Treasuries reducing by not replenishing maturities and then a potential rate-hike in 2015. In this scenario, again which I think is very unlikely, yields would rise sharply to close to 6 per cent."
Spreadbury has managed the Fidelity Strategic Bond fund since its launch in April 2005.
According to FE Analytics, over that time the fund has been the third-best performing fund in the IMA Sterling Strategic Bond sector, with returns 64.3 per cent, beating the sector average by more than 20 percentage points.
Performance of fund vs sector since Apr 2005
Source: FE Analytics
Given that he believes yields will remain low for the foreseeable future, he says he is happy to hold high-quality investment grade credit.
"I do think that investment grade bonds are probably still the sweet spot," he said.
"Current spreads are 1.33 per cent in UK corporates, and when you consider the historical default risk – or cost of default – is no more than about 20 basis points, I still think we are getting adequately paid for that illiquidity risk and volatility."
"I think the reach for yield in this environment and QE will continue. Though it will be volatile, the value is certainly in high-quality investment grade bonds."
However, Spreadbury says that investors need to be very selective as there are certain areas of the market that are riskier than others.
"Credit risk is rising and credit quality is deteriorating. I think that what is happening here is that some companies are saying 'look at the low yields' and feel that it is a golden opportunity to raise money and potentially buy back shares or get involved in M&A."
"I think what we are not seeing in a big way is companies raising money for investment, which will be a concern for growth going forward."
"Clearly stock selection is important and we focus on companies where we feel credit quality is stable, as credit risk in the market is rising on the whole," he added.
Non-financial investment grade credit makes up nearly 30 per cent of Spreadbury’s portfolio, because he feels that now is no time to be taking risk.
"The events of the last few weeks have shown that there is potential downside. I think the problem is the amount of debt is so high in developed markets, that the feedback loop from the markets into the economy could be quite significant and the authorities know that."
"So I think recent events show how nervous markets are and how far away we are from any reversal or stopping of QE."
"To cover or to hedge against that downside economic risk, I have been focused on high-conviction credit from less economically sensitive companies, such as food and drink, and telcos, so a real focus on non-cyclicals."
Although he says yields and interest rates will stay low, the manager admits he is keeping an eye on his duration, which is currently 5.5.
Fidelity Strategic Bond has an ongoing charges figure (OCF) of 1.21 per cent and requires a minimum investment of £1,000.
