There is little doubt that the performance of government bonds will have caught out the large majority of investors over recent years.
As a result of tighter monetary policy in the US and UK and improving economic conditions, 2013 was seen by many as the year that the multi-decade bull run in fixed income would come to an end as bond yields spiked.
However, as a result of growing macro worries, equity market volatility and falling inflation expectations, yields of developed government bonds fell once again last year – meaning they outperformed most equity markets in 2014.
Performance of indices in 2014
Source: FE Analytics
Opinion is still very much split over what bond prices will do next, but as yields on the likes of 10-year gilts and treasuries are towards their historic lows, Lockyer – co-manager on the PFS Hawksmoor Distribution and Vanbrugh funds – is extremely cautious on traditional fixed income assets.
As a result, he has just bought William Littlewood’s (pictured) Artemis Strategic Assets fund as the manager’s negative exposure to the bond market means his portfolio should be a prime beneficiary in a rising yield environment.
“Artemis Strategic Assets is a very new investment for us as we only initiated a position a week ago,” Lockyer said.
“That was on the basis of our feeling that bond yields are finding a level now as a big percentage of the world’s bond market is negative – one-fifth of developed government bond markets are now negative and nine countries have two-year bonds on negative yields.”
“We have done some analysis and we don’t think bond yields can go more negative. Having had a headwind for this fund as William Littlewood has stayed short government bonds despite the fall in yields, we now think that position will turn into a tailwind for him and that will be a driver for future returns.”
Littlewood, who has built up a strong following as a result of his time at Jupiter and as a hedge fund manager at Artemis, has long held the view that government bonds are overvalued and this has hurt the relative performance of his fund since its launch in May 2009.
According to FE Analytics, the £916m Artemis Strategic Assets fund has returned 63.31 per cent over that time, placing it in the bottom quartile of the IA Flexible Investment sector and meaning it has underperformed against its FTSE WMA Stock Market Growth benchmark by close to 30 percentage points.
Performance of fund versus sector and index since May 2009
Source: FE Analytics
Littlewood is currently gross 99.1 per cent short government bonds, which represents 45 per cent of his total portfolio exposure. While this positioning has hindered performance, in his most recent note to investors, the manager said he will stick to his guns and continue to bet against the fixed income market.
“I do not recall a chapter in Graham and Dodd’s Security Analysis dealing with negative investment yields. Do investors truly understand that they are paying for the privilege of lending to governments?” Littlewood said.
“Low yields on government bonds have an impact on all other asset classes, making everything else appear relatively cheap. But I do not trust yields to stay low indefinitely.”
“I do not like this backdrop and remain cautious. We reduced our equity position again this month, added to holdings in precious metals and remain as short of government bonds as we are permitted.”
Lockyer isn’t fazed about Artemis Strategic Asset’s past performance either.
While some have questioned why the manager has bought a fund which has struggled relative to its sector and benchmark over recent years, Lockyer explains that he picks funds to play a certain role or give access to a specified theme in his portfolios.
“It’s all about the future returns, rather than looking at the past track records. We’ve owned Strategic Assets in the past – we sold it about three years ago – but we think now is a good time to go back in and benefit when bond yields start rising,” he explained.
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, has used the fund for a number of years now and while he admits that many investors may have lost patience with Littlewood’s lacklustre returns, he agrees now is a good time to look at the fund.
“We’ve supported the fund and William Littlewood for a number of years now and, clearly, his views on the bond market have been dead wrong,” Morgan said.
“The fund performance has been okay and that is because it had exposure to the US equity market and made some reasonable currency calls. However, I’m inclined to agree that bonds have reached a point where they offer very little upside potential but a lot of downside.”
“Of course, however, he could continue to be wrong for a little while yet.”
Plenty of experts disagree with the view that bond prices will start to fall, of course.
The major argument against such a phenomenon is that bond yields will only rise materially if interest rates do.
As inflation expectations have fallen thanks to a lower oil price, as there still huge levels of debt in the system and as homeowners in the US and UK are already stretched with their current mortgages, some say the chances of a hike, and therefore a bond crash, over the short term are very low.
Morgan certainly sees this point of view, but says Artemis Strategic Assets is good option for investors looking to diversify their portfolio as it should protect them if the bond market were to fall out of bed for any reason.
Our data shows, for example, the fund has been negatively correlated to the performance of government bonds over recent years.
In 2013, when the Barclays Sterling Gilts index lost 4.22 per cent, the fund returned 14.41 per cent while in 2014 – when yields dropped and the index gained 14.64 per cent – Artemis Strategic Assets lost 1.71 per cent.
Though 10-year gilts only yield 1.86 per cent, they had started the year at below 1.4 per cent meaning that the index is down 0.76 per cent year to date. On the other hand, the fund is up 3.73 per cent so far in 2015.
This negative correlation is clearly shown if you plot the performance of the fund against the index since January 2013 – as we have done below – as they have moved in the complete opposite direction to each other over that time.
Performance of fund versus index since Jan 2014
Source: FE Analytics
Morgan points out that while there are a number of funds which are positioned for a bear market in fixed income, Artemis Strategic Assets is one of the only portfolios out there that is positioned to make money from a bond crash.
“There are plenty of strategic bond funds which are duration neutral, but apart from the Littlewood’s fund, there aren’t many ways for private investors to play the theme of rising bond yields,” Morgan said.
He added: “I think it is a good fund to buy if you take the view that bond prices will start to fall and in William Littlewood you are getting a very good fund manager.”
While Littlewood is massively short bonds, the fund is set up to be a traditional multi-asset portfolio.
The manager invests across equities and commodity markets – taking both long and short positions – and will also use different currencies. He currently holds 60 per cent in equities, 15 per cent in commodities (which include physical gold, silver, platinum and palladium) and 24 per cent in cash.
Artemis Strategic Assets is also short the euro and yen, but is long the Singapore dollar and the Norwegian krone.
Its ongoing charges figure is 0.87 per cent.