UK and other government bonds have fallen out of favour with investors recently as high starting valuations, an economic recovery and talk of an end to QE have pushed yields higher.
Performance of indices over 1yr
Source: FE Analytics
This has meant that many bond-holders, who would usually have exposure to the asset class for the purposes of protection, have been hit by capital losses.
While market commentators expect a similar scenario this year, Peirson (pictured) says that risk-averse investors could soon have a good opportunity to buy into the gilt market. “I can see a situation at some stage this year that when yields rise, I will invest more into government bonds again,” Peirson said.
“We will only buy gilts again if yields rise; if yields on 10-years were to reach 3.5 per cent, then we would begin to consider them for the fund.”
Ten-year gilts are currently yielding 2.84 per cent, having fallen from 3 per cent a week ago.
Peirson, like many of his counterparts, is still more positive on equities than bonds. However, the manager says that there are still macro risks facing the market, so gilts will soon help to provide a good protective buffer for his portfolio.
“I recognise that though my investors want consistency of returns, they don’t want huge amounts of volatility,” he said.
“We hold 20 per cent in cash and bonds as an insurance policy. It provides us with a buffer and also helps us take advantage of falls in the equity market. People ask me that as I have been cautious on bonds and because cash isn’t giving you anything, why don’t you own more equities?”
“That’s all very well, but I want that insurance policy. I can’t tell if my outlook is right and using an analogy, just because your house hasn’t burned down yet, that doesn’t mean you don’t need to re-insure it,” Peirson added.
Although Peirson’s thoughts on government bonds leave him largely in the minority, a number of managers have already begun to dip back into the gilt market.
One such name is FE Alpha Manager David Coombs, who has started upping his exposure to 10-year gilts in his Rathbone Multi Asset Portfolios in order to protect his investors against high valuations in the equity market.
“We are putting money to work in UK government bonds, and purchased the 10-year at the start of the year on a 3.07 per cent yield.”
“Valuations elsewhere are looking richer, and the allocation helps us mitigate equity risk. We will look to buy up to 4 per cent,” Coombs said.
While bonds had a difficult 2013, equity markets across the developed world delivered very high returns for investors.
According to FE Analytics, the FTSE All Share returned more than 20 per cent last year which was its second-best discrete annual calendar return over the last decade.
Performance of index in 2013
Source: FE Analytics
However, while Peirson is still generally bullish on equities, he expects returns from the UK market to be markedly lower this year than they were in 2013.
“I think it is a function of valuation,” he said.
“Equities around the world, while not expensive, are no longer cheap. I think economic growth will translate into better earnings, but I don’t expect to see that until the second half of the year.”
“One of the reasons for that is sterling headwinds, given the fact that 70 per cent of the UK market’s earnings are international.”
“I think we could see high single-digit earnings growth by the end of the year, but that won’t be a huge push for equities given their current value. I think markets will be up by around 10 per cent or high single digits,” he added.
However, Peirson says that a pick-up in merger and acquisition (M&A) activity is one of the factors that could cause him to revise his outlook upwards.
“One of the surprises last year, which perhaps shouldn’t be too much of one, was that M&A activity wasn’t a feature,” the manager said.
“When financing costs are so low because of low interest rates and companies have a lot of cash on the balance sheet, making acquisitions is earnings-enhancing. However, last year there just wasn’t that confidence.”
“This year, I think management teams will be more comfortable. China is a concern, as its economic restructuring is underway, but it is still growing. I think we could see management teams taking advantage of the low financing costs and because of that, returns from equities could be rather higher than single digits.”
Our data shows that Peirson’s four crown-rated AXA Framlington Managed Balanced fund is a top-quartile performer in the IMA Mixed Investment 40%-85% Shares sector over one, three, five and 10 years.
The fund has returned 148.42 per cent over the past decade, beating the sector average by close to 60 percentage points.
Performance of fund vs sector and index over 10 yrs
Source: FE Analytics
While Peirson oversees the whole fund, he is only responsible for picking its exposure to fixed income UK equities. Other regional managers at AXA Framlington decide on its global weightings.
However, the UK is his largest weighting as it makes up close to 40 per cent of the fund, with the likes of HSBC, Vodafone, BP, GlaxoSmithKline and Royal Dutch Shell all featuring in his top-10.
The AXA Framlington Managed Balanced fund has an ongoing charges figure (OCF) of 1.27 per cent and requires a minimum investment of £1,000.