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Spreadbury: Yields may be extremely low, but you’d still be a fool to sell your bond fund

12 November 2014

FE Alpha Manager Ian Spreadbury tells FE Trustnet why investors can expect bonds to continue to surprise on the upside over the next 12 months.

By Alex Paget,

Senior Reporter, FE Trustnet

Bonds will continue to perform well in 2015 even though sovereign debt yields are near their all-time lows, according to FE Alpha Manager Ian Spreadbury, who says investors are wrong to think the rally in fixed income is over.

Though many expected 2014 to be a dire year for bondholders due to factors such as a recovering global economy and the prospect of tighter monetary policy in the US and UK, as investors will be well aware, the complete opposite has been true.

Ten-year gilt yields had started 2014 at around 3 per cent but have since rallied to 2.19 per cent. This in turn has hurt the large majority of professional investors on both a relative and absolute basis, as many had favoured higher risk assets – which have been flat this year – in favour of their traditional safe haven bond exposure.

Performance of indices in 2014

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Source: FE Analytics

Although several industry experts have admitted they were caught out by the performance of bonds so far this year, very few have predicted that the rally will continue as government bonds, corporate credit and high yield bonds now look expensive relative to their histories.

However, Spreadbury – manager of the multi-billion pound Fidelity MoneyBuilder Income and Strategic Bond funds – says investors are making a mistake if they think now is the right time to sell down their fixed income holdings.

“Even with yields at such low levels, it still makes sense to invest in bonds. My view is that high quality bonds are around fair value at these levels,” Spreadbury (pictured) said.

ALT_TAG “Aside from valuations, bonds clearly do a number of things for investors. One is that they provide a level of income. Two, they work well as equity diversifiers – particularly high quality bonds – and with relatively low volatility, and that has been the case over the last year.”

“I would expect that to continue to be the case going forward.”

One of the most outspoken critics of the current fixed income market has been the Schroder MM team.

FE Alpha Manager Marcus Brookes, who heads up the fund of funds range with Robin McDonald, warned investors last month that they should avoid the “extremely expensive” bond market at all costs. Brookes is instead holding close to 40 per cent cash in some of his portfolios rather than using fixed income funds.

“We believe the recent strength is due to safe haven buying whilst equities are weak, but once this theme runs its course perhaps the shock will be how weak these securities will be,” Brookes said.

Spreadbury, on the other hand, is far more constructive on the asset class. His base case is that 2015, like 2014, will be characterised by low growth and low inflation, which will keep bonds very much en vogue.

“We appear to be in this environment of low growth, low inflation and ultra-low yields. What is causing it? Well, I think one of the fundamental problems is debt to GDP both in the UK and across most of the developed world,” he explained.

“In my opinion, there is a global propensity to save and that is driven by those high levels of debt. That is depressing aggregate demand and causing a level of spare capacity which has surprised many economists and is pushing down on inflation. In itself, this desire to save is pushing yields down.”

“I think it is disappointing with interest rates at such low levels over the last five years that overall debt levels have stayed so high; so like with running a highly leverage company, I think the systemic risk is high which is possibly not being recognised by the market.”

One of the major headwinds facing bondholders is the prospect of higher interest rates over the short term; though many have questioned whether a hike will happen given the lack of inflation and as the general election is only around the corner.

Spreadbury says the Bank of England will want to raise rates sooner rather than later, but given that there is so much debt in the system he only expects an incremental rise. Therefore, though he anticipates a “modest hike” over the coming 12 months, he firmly believes the market has already priced in that event.

Another major concern which has been widely discussed by fixed income market commentators is declining liquidity in corporate credit.

Spreadbury fully agrees that this is an issue – especially with high yield debt – but says the current spread on investment grade bonds gives investors enough of a buffer.

“The fact is liquidity in corporate bond markets hasn’t been great. It has deteriorated since the credit crunch and I don’t think it is going to improve anytime soon,” he said.

“However, I think we are being paid for that illiquidity in investment grade bonds. I also think that we can manage illiquidity, i.e. do my best to do that at the fund level by keeping significant chunks in government bonds.”

Spreadbury has managed the £3.1bn Fidelity MoneyBuilder Income fund since October 1995.

According to FE Analytics, it has been a top quartile performer in the IMA Sterling Corporate Bond sector over that time with returns of 63.69 per cent, beating the sector in eight of the last 10 calendar years.

Performance of fund versus sector over 10yrs


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Source: FE Analytics

The FE Alpha Manager launched his £1.5bn Fidelity Strategic Bond fund – which has a higher degree of flexibility – in April 2005 and it has been a top quartile performer in the IMA Sterling Strategic Bond sector over that time with a 76.44 per cent return.

Due to Spreadbury’s more cautious approach to running fixed income funds, both portfolios have tended to be less volatile than their respective peer groups.

Fidelity MoneyBuilder Income has a yield of 3.79 per cent and an ongoing charges figure (OCF) of 0.57 per cent, while Fidelity Strategic Bond has a yield of 3.76 per cent and an OCF of 0.67 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.