Cautious investors have had a difficult time recently as yields on the majority of traditional fixed income assets – such as gilts – have moved higher over the last 12 months. This means that a lot of investors who had bought into those bonds due to their “safe-haven” characteristics have been hit by capital losses. While Jane had previously steered well clear of gilts due to their high valuations, he says that there are now very good opportunities at the long-dated end of the market for investors who want to protect that capital and hedge risk.
The major reason for that, he says, is because the investors have been buying up short-dated bonds and have not wanted to lend money for the long term, meaning that 30 year plus gilts now look attractively valued.
“The way I generally look at it is there is a fair chance that short term rates move higher in the US and the UK, which will cause the curve to flatten [as shorted-dated bond yields rise],” Jane said.
“Yields have trended higher over the last year or so but I think they will settle at a range between 3.5 to 4 per cent, given where inflation and nominal GDP are. That would mean that long-dated gilts, I think, are fairly priced.”
“We have just bought a 38 year gilt which is yielding 3.5 per cent, which is actually as much as you can get from a lot of high yield bonds. OK, you might get more capital volatility with long-dated gilts but there is a hell of a lot more risk in high yield.”
He added: “Everyone has been ultra-short duration and has been trying to reduce their interest rate risk, but we have seen quite shift in yields recently.”
According to FE Analytics, the FTSE British Government All Stocks index has posted a negative return over the last year.
Performance of indices over 1yr
Source: FE Analytics
The major reason for those losses, however, was due to the May/June sell-off as a result of Ben Bernanke’s tapering speech which caused yields to spike. Since the start of the year, for instance, gilts have actually performed well with 10 year gilts returning close to 5 per cent.
FE Alpha Managers John Pattullo and Jenna Barnard, who run the Henderson Strategic Bond fund, recently told FE Trustnet that they too had been buying longer dated debt as the yield curve is now very steep.
“You can still lend long and make money from it, so to speak. If rates were to come up, the front end of the curve could also come up, which would mean you are losing money in short bonds. Long bonds may, or may not, be a relative safe haven in that scenario,” Pattullo said.
However, Jane says that if he is going to be buying long-dated gilts they have to be “very long-dated”.
“Generally we think short term interest rates are likely to be moving hire over time to say, 2 per cent.”
“This is likely to push yields on 10 year gilts higher from current 2.5 per cent levels, whereas in the 30 year bond we get 3.5 per cent yield and arguably better protection from the equity market volatility in exchange for higher yield but slightly higher volatility.”
The big caveat to that, however, is that inflation may trend higher.
However, inflation in the UK has been falling with official figures falling below 2 per cent. Jane says that while inflation is a risk over the long term; he sees little point setting up for that eventuality in a portfolio now as it will just lead to underperformance.
Jane launched his £50m TM Darwin Multi Asset fund in May 2011, having previously been head of equities at M&G.
According to FE Analytics, since launch the fund has returned 15.63 per cent and has narrowly beaten the IMA Mixed Investment 20%-60% sector in the process.
Performance of fund vs sector since May 2011
Source: FE Analytics
The fund has tended to have a higher allocation to equities and lower exposure to bonds than the majority of its peers, which helped its performance last year when it was a top quartile performer with returns of close to 14 per cent.
Currently, equities make up 56 per cent of Jane’s fund with the limit being 60 per cent.
However, the make-up of the portfolio hasn’t helped the fund’s returns this year as equity markets have been broadly flat due to concerns in the emerging markets and geo-political risk in the Crimea. Our data shows that TM Darwin Multi Assets has fallen into the bottom quartile 2014 with losses of 1.32 per cent.
Jane had told FE Trustnet in the past that he was bullish on equities and while he has added a few fixed income positions, he fully expects the rally to continue after its pause in the early stages of 2014.
“Markets have had an annoying start to the year,” he said. “We did end last year on a higher, but we have seen a correction of some sorts. However, I think we are in a medium term upswing with markets and the economy and we will stick with that view until proven otherwise.”
“We have been sticking with decent value stocks that offer a good yield during this rocky patch. Valuations aren’t obscenely high but people are waiting for earnings growth to come through; clearly the risk is that it doesn’t.”
Jane added: “However, I would expect the rally to continue this year as people start worrying less about Putin and Eastern Europe and focus on economic recovery again.”
TM Darwin Multi Asset has an ongoing charges figure (OCF) of 1.8 per cent.
