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Aberdeen’s Hickmore: Why a selective approach is needed by bond funds

26 November 2015

The strategic bond fund manager thinks there are plenty of opportunities in today’s fixed income market but is very careful over where he chooses to put money.

By Gary Jackson,

Editor, FE Trustnet

 
Investors needn’t overly fear the start of a fixed income bear market but there is a growing need for bondholders to be selective when it comes to asset classes, geographies and currencies, according to Aberdeen’s Luke Hickmore.

Investors have been paying close attention to bonds over recent years as speculation mounts over when the Federal Reserve and the Bank of England will make their first interest rate rises since the global financial crisis.

Bonds were tested in May 2013 when then Fed chair Ben Bernanke first hinted that the central bank was preparing to end its quantitative easing programme – sparking the so-called ‘taper tantrum’ – and although most bond funds are up since then, the concern now is that interest rate rises will have an significant impact on the market.

Performance of sectors since taper tantrum

 

Source: FE Analytics, bid-to-bid performance with dividends reinvested between 22 May 2013 and 30 Sep 2015

While bonds have enjoyed a 30-year bull run, sceptics warn that the move to a rising interest rate environment could spell the end of this and suggest significant losses could be on the horizon for the asset class.

Hickmore, who runs the Aberdeen Strategic Bond fund with Roger Webb, expects bond markets to remain more volatile than they have been in the past but says there are still opportunities present if investors know where to look.

“For us, expecting a slow rise in rates with low growth and low inflation, yields will go higher but not dramatically and possibly not even enough to wipe out the carry. You could end up having reasonably positive returns from bonds for the next few years,” he said.

“The time an investor would need to dramatically change their asset allocation would be if rates were going to be hiked aggressively, growth suddenly went on a tear and inflation came through strongly. There’s just not enough of that around to push yields to aggressive levels. If we end up with 3 per cent yields in a year, you’ll still make money from bonds.”

However, this doesn’t mean that investors can just buy any bond and expect healthy returns regardless. The manager argues that selectivity will be the key from here on, with nimble funds that can cherry-pick from the vast opportunity set on offer being those best placed to maximise this.


 

For example, Aberdeen Strategic Bond’s managers currently prefer debt issued in the UK and Europe over US bonds. Hickmore explains that this is because it will take longer for economic growth and stronger inflation to come through on this side of the pond, which means the environment is likely to be more supportive for fixed income assets.

When it comes to asset classes the managers have a “modest” preference for high yield bonds over investment grade, especially when it comes to Europe. However, Hickmore (pictured) says that the weak economic backdrop could eventually prove troublesome for this part of the market – although not necessarily any time soon. 

“What we’ve seen with high yield is many years of quantitative easing and easy money, which has made it easier for issuers to refinance themselves and avoid defaults. But we need growth to come through as well,” he explained.

“We have a relatively narrow window of about three years where high yield still works in Europe before we need to see some growth so they can pay the leverage back.”

Aberdeen Strategic Bond’s most recent factsheet shows it had close to 40 per cent of assets in bonds rated BB, B or CCC, as at the end of August.  

Looking at investment grade exposure and the manager also highlights the need for a careful approach but says the sell-off seen in this part of the market over recent months has opened up interesting opportunities.

“The move to wider spreads in investment grade over recent months has just made the asset class more attractive,” he said. “At the moment, it’s a good place to be for investors – there’s a buffer being brought in for you.”

In European investment grade, the fund’s managers prefer bank debt thanks to the balance sheet repair the sector is undertaking, although he stresses the need to be “incredibly selective” about where to buy in the capital structure. Names held in the UK include Barclays, Lloyds and RBS.

Over in the US, however, and the fund is finding more opportunities within investment grade industrial names. The banks here are less attractive, Hickmore explains, as they have largely finished efforts to strengthen their balance sheets.

While Aberdeen Strategic Bond is mainly a pan-European fund, it has been slightly increasing exposure to emerging market debt. The portfolio has a small position in the recently launched Aberdeen Global Indian Bond fund, for example.

“I’d love to get Indian bonds directly but it’s really difficult: the permissions you need to get local bonds are hard to secure,” Hickmore said.

“But that’s part of the reason you buy it – the improving structure of the market is happening at a decent pace but you want to be in it now as all the benefit will be gone by the time it gets to be easy to open an account.”

Emerging market exposure has also been taken to Indonesian ports, as a play on the government’s move to modernise them to make the country a trading hub between China and Australia, and stated-owned enterprises that are “crucial” to China’s growth, such as Beijing Underground and a toll road in Guangdong.

The manager also points out that a selective approach doesn’t mean the fund has to end up with a concentrated portfolio, which could be more risky. Indeed, the fund has recently been increasing its number of holdings to take advantage of fresh opportunities as well as to diversify risk.


 

“We have the luxury of taking what we want, rather than being forced into stuff we don’t want. Those incremental additions to the portfolio have been useful,” he said.

“The vast majority of bonds in our portfolio are hand-selected. There’s greater dispersion in markets now so the opportunity set is getting bigger.”

“It used to be that it didn’t matter what you bought because you just needed beta, but that’s not the case anymore. The past two months have shaken all that out entirely and you’re finding stuff coming out of this that are very attractive for their risk.”

Between its launch in June 2010 and the end of September 2015, Aberdeen Strategic Bond outperformed its average peer in the IA Sterling Strategic Bond sector with a 33.65 per cent total return.

Performance of fund vs sector since launch

 

Source: FE Analytics, bid-to-bid performance with dividends reinvested between 14 June 2010 and 30 Sep 2015

 

The value of investments and the income from them can go down as well as up and your clients may get back less than the amount invested. Aberdeen Asset Managers Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Past performance is not a guide to the future. 

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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.