Co-fund manager Gareth Isaac attributes the fund’s outperformance to the fact that the investment team follows a strategy to add long term value and invests on the basis of where markets will go in the next 12 to 18 months. Isaac and co-manager Lorenzo Gallenga used to run funds at Newton Investment Management (now BNY Mellon Asset Management) where the investment strategy involved selecting investment ideas with a long term view in mind, as it was considered this would produce the right medium term decisions.
Strong performance
Back in September 2007 the managers took a more negative view of the UK economy than many of their peers, because they perceived heavy bias towards the services sector.
“In the second quarter of 2008 the market discounted interest rate rises and corporate bond spreads narrowed,” says Isaacs. “But we looked at the UK economy and thought that there would be a severe downturn even though the credit markets were predicting something different – we did not buy into the recovery story.”
As a result they sold many of the more volatile bonds in the fund’s portfolio. This included subordinated debt issued by banks – portions of bonds where the bondholder has lower repayment priority in the event of a default. The higher risk is compensated with higher interest payments on the debt.
The managers also ensured the fund had little exposure to mortgage and asset backed securities, as well as bonds issued by banks and insurance companies which they considered to be the greatest risks.
Current exceptions to this approach include short-term bonds issued by Royal Bank of Scotland, Lloyds and HBOS; as one of the government initiatives to reinvigorate the UK banking sector has been to guarantee short-term clearing bank debts. This means it is akin to taking on UK government debt which is 'AAA'-rated, implying extremely low default rates, Isaac suggests.
While there has been speculation that credit ratings agencies might downgrade the UK’s sovereign rating, Isaac says they have indicated this is unlikely in the short term, during which these bank bonds should reach maturity. The chances are increasing of a sovereign rating downgrade, Isaac adds, as the UK government increases the nation's sale of debt.
He expects the budget deficit to rise by a £100bn more over the next three years than was indicated in November’s Pre-Budget Report, partly due to expectations that bank losses will increase because of a rise in reposessions relating to mortgages and other loans. The fund also focuses on buying new bond issues rather than illiquid secondary market ones as Isaac feels these are more fairly priced.
Sector top performers over past year
|
Fund |
1y | 3y | 5y |
|---|---|---|---|
| SG Core Plus Sterling Bond Inst Acc | 10.5 | n/a | n/a |
| Jessop (AAM) Sterling Bond PP Acc | 9.0 | n/a | n/a |
| M&G Strategic Corporate Bond A Acc GBP | 7.9 | 7.3 | 21.0 |
| CF Canlife Bond | 7.1 | 2.3 | 13.4 |
| Rensburg Corporate Bond Trust | 3.7 | 4.2 | 14.1 |
The fund assesses the value at risk and tracking error of each investment in the fund to give a clear idea of where the risk lies, with strict limits on the level of the tracking error. At the end of December 70.1 per cent of the portfolio was invested in 'AAA'-rated bonds – the ones considered least likely to default by rating agencies such as Moody’s and Standard & Poor’s - with 97.1 per cent of the portfolio in investment grade bonds – ones rated 'BBB' or higher - suggesting the portfolio is low risk.
The fund does not invest in high yield bonds and currently avoids exposure to Eastern Europe, an area over which rating agency Moody’s recently expressed concern; it has threatened to downgrade Western European banks with local subsidiaries there. This is mainly a problem for Austrian banks.
The fund is currently focused on bonds issued by companies in sectors considered more resilient to the economic downturn, such as: utilities, telecoms companies and tobacco. That said, the fund still considers positions that can add relative value. It has bought bonds which should benefit from the Bank of England making interest rate cuts.
SG Core Plus Sterling Bond Fund also makes use of its investment powers under UCITS III to buy futures exploiting the weakness of sterling against the dollar. Futures are liquid and have low dealing costs, while the bid-offer spreads on bonds are wide.
The fund will maintain a defensive position over the first half of 2009: expectations are for tighter corporate bond spreads in the short term as the Bank of England spends up to £50bn buying private sector assets including corporate bonds. Isaac admits there is great value in current spreads, which he belives is mainly accounted for by lack of liquidity rather than default risk.
Spreads are discounting enormous default rates, and Isaac thinks it highly unlikely defaults will get anywhere near that. However, he does expects the UK economy to deteriorate further, so that by the third quarter of this year spreads could widen further still, providing even better value opportunities. Therefore around the fourth quarter the fund will look to add risk, taking positions the managers expect will do well in 2010.