The rising yields on government bonds such as US treasuries and UK gilts have translated into poor capital performance in recent months. Though both have traditionally been viewed as safe-havens in recent years, treasuries and gilts have broadly lost investors money over the last 12 months.
Performance of indices over 1yr
Source: FE Analytics
With risk-averse investors needing a safer option within their portfolio to offset higher risk assets like equities, many are watching rising gilt yields with a watchful eye, waiting for a time to pounce on an attractive entry point.
Binns, who manages the Royal London Duration Hedged Credit fund, says that gilt yields will inevitably go up from here – 10-year gilts are currently yielding 2.93 per cent – as tapering ends and interest rates eventually rise.
She says cautious investors could start to dip back into the asset class quite soon, and pinpoints 3.5 per cent as a figure to look out for.
“In terms of gilts, our forecasts are that yields will keep moving upwards. However, we have already seen a big move so far this year,” she said. “I think that when yields reach 3.5 per cent, then you could see investors returning to them in that scenario. But, you wouldn’t really be looking to buy back into them until they reach those sorts of levels.”
“Nevertheless, 3.5 per cent to 4.5 per cent represents a normal trading range so I could certainly see people then taking a look again,” she added.
As Binns highlighted, gilts have been particularly volatile so far this year.
Having been as low as 1.7 per cent last year, yields hit 3 per cent a couple of weeks ago. They did give some of that yield back in light of Fed Chairman Ben Bernanke’s decision to keep QE at the same level.
Despite the rise in prices some managers, such as Darwin’s David Jane, says there is little in the way of technical resistance when it comes to rising gilt yields and expects prices of government bonds to keep falling for the foreseeable future as a result.
Binns says interest rates will be the major influencing factor on gilt yields. If they remain at their current levels, which most expect will be the case for at least a year, she thinks investors will be happy to buy gilts at 3.5 to 4.5 per cent.
“It really all depends on base rates,” she explained.
“I don’t see the base rate rising any time in the next 12 to 14 months and we are really more in the 14-month camp. The view is and our forecasts are that we will see robust GDP growth of 1.1 per cent, but that isn’t anything to shout about.”
“I think central bankers will keep short term rates as low as possible for as long as possible until there is better economic growth,” she added.
Binns has managed the Royal London Sterling Credit fund since September 2008. She also runs the £100m Royal London Duration Hedged Credit fund, which was launched last September with the sole intention of helping wary fixed income investors.
“The idea behind the fund was instigated by an external client. They wanted to take the value of corporate bonds to fully match their liabilities but take the duration risk down to zero,” Binns explained.
“However, the important point is the timing around the fund’s launch. What we have found is that there are other clients who want to take away interest rate risk from their credit exposure but still capture value.”
“Our view is that interest rates are too low and we don’t want exposure to them eventually going up. Over the last year, you have seen flat to negative returns from the corporate bond market but in this fund we are able to capture the improvement in price and deliver a positive return,” she added.
According to FE Analytics, the Royal London Duration Hedged Credit fund has returned 6.6 per cent since launch and has easily achieved its objective of LIBOR plus 2 per cent. As a point of comparison, it has also beaten the IMA Sterling Corporate Bond sector.
Performance of fund versus sector and index since September 2012
Source: FE Analytics
Binns says that the fund is predominantly a corporate bond fund and its structure means that it looks “pretty much looks like any other corporate bond fund”. For instance she says she favours secured debt over unsecured debt because it is cheaper and as the risk/reward characteristics are better.
However, she says there are some notable differences to traditional bond funds. Binns uses interest rate swaps to manage the fund’s duration risk. Also, the manager holds a proportion of the portfolio in short-dated gilts for “collateral purposes”.
Binns says the fund offers investors an alternative way to play the fixed income market, but she admits that this sort of fund is having its time in the sun given the fact that most other bond funds will be hindered by rising yields and rising interest rates.
“If interest rates were to fall, then that wouldn’t benefit a fund like this,” she said. “However, we just can’t see that happening for a long time to come. But, we have a broad range of funds here and you can move between the products easily.”
The fund is geared towards more institutional investors. However, it is available on a number of fund platforms and has an ongoing charges figure (OCF) of 0.57 per cent.
