Hodges (pictured), who manages the $108.3m Nomura Global Dynamic Bond fund, said he has previously warned over valuations in the credit market.
He said: “For some time, we have voiced our view that credit is supported more by relentless buying pressure in the global hunt for yield rather than by great fundamental strength.
“We have repeatedly stated that valuations appear stretched and that the potential scale of a market panic in the wake of volatility is growing, even if the causes for that panic are difficult to foresee.
“Our risky asset sales and duration increase were designed to partially insulate the fund from a worsening of conditions.”
Hodges said the mid-month “wobble” in credit markets during May had been a cause for concern, leading to the fund taking profits on a couple of “risk positions”, Orazul Energy and Bankia.
The manager said he had also increased duration in the fund, as well as offloadng its position in Noble Group.
He added: “Although we doubted that the ‘wobble’ would descend into full-scale panic, the possibility was there, hence our defensive action.”
According to the most recent Fund Manager Survey by Bank of America Merrill Lynch, fund managers maintained a 57 per cent underweight to bonds during May, up from 62 per cent during the previous months.
Analysts at the bank have also flagged the risk of a Fed policy error, should the US economy find tightening difficult to deal with.
Indeed, despite having benefited from its duration positioning, the manager has added more protection for the portfolio against the move reversing by purchasing US Treasury put options.
Midpoint of target range or target level for the federal funds rate
Source: Federal Reserve
He explained: “If the Federal Reserve fails to hike rates in June, it is possible that risk will rally and Treasuries sell off – hence our desire for the protective position.
“We continue to position for the potential effects of further rate rises in 2017, although we are far from convinced that inflationary pressures will be strong enough to force the Fed to move quickly.
“We are short the US Treasury two-year, and long the 10-year bonds: this latter position expressed partially through options.”
Hodges added: “Sovereign bond yields continue to offer little value and we have hedged a portion of our eurozone duration through a 10-year Bund put position.”
However, the manager said that despite some of the challenges facing credit markets it continues to believe that risky assets have further to run but with the caveat of stretched valuations, while continued positive capital returns “cannot continue indefinitely”.
He said: “Thus we must balance the desire to hedge downside risk with our belief that we have not yet seen the final capitulation of markets into all-out risk and, perhaps more importantly, the belief that there are few looming reasons for the market to panic and reverse its recent trend.”
Concerns have been increasingly raised elsewhere, most notably in Australia where Hodges said there are several signs of a slowdown.
He said: “The housing market is stretched and consumption is weakening. Any sign of weakness in China – Australia’s largest customer for its raw materials exports – could put further pressure on the economy.
“We have added outright CDS [credit default swap] protection on a basket of Australian companies to our long-held CDS positions in the major Australian banks.
“At month end, we continue to have a degree of credit hedging in place. A protective payer/put option guarding against widening in financials spreads is partially financed by giving away some potential upside through the sale of a call/receiver option in the same CDS index.”
“There are pockets of value to be found in the fixed income sphere,” Hodges added. “We continue to be selective and will back those selections with conviction.”
Hodges has managed the FCA-recognised offshore fund since 2015. It aims to deliver a combination of income and growth investing principally in debt securities with fixed or variable rates of income. Over one year the fund is up by 22.77 per cent, when rebased into sterling, compared with a 13.75 per cent gain for the average FO Fixed Interest – Global fund.
Performance of fund vs sector over 1yr
Source: FE Analytics
The fund has an ongoing charge figure (OCF) of 0.82 per cent.