Cunningham, who manages Newton’s five crown-rated Long Corporate Bond fund among others, says the next few years will be a difficult time for fixed income investors and they cannot expect to see the same capital returns of the past half a decade or so. "I think it will all be about the coupon return," Cunningham said. "We have had some positive events recently with banks buying back bonds at a big premium, but there will be less of that going on now. But let’s not underestimate the power reliability of investment grade credit coupons."
Despite his seemingly defeatist view of the fixed income market, he does feel that many investors have become overly pessimistic about the outlook for bonds.
According to FE Analytics, the iBoxx Sterling Non-Gilt All Maturities index has returned just over 2 per cent so far this year, with high levels of volatility, while the FTSE British Government All Stocks index lost money.
Performance of indices in 2013
Source: FE Analytics
A number of industry experts – such as David Jane – say that there is little point in holding traditional bonds such as gilts or investment grade credit as there is no technical resistance stopping yields rising, and therefore prices dropping, over the short- to medium-term.
However, Cunningham says a lot of commentators have overreacted.
"It has become an annual sport really, where every year people are talking about the demise of fixed income," he said.
"I was speaking to one of my equity colleagues and he was saying that the problem with equity markets is that they tend to go up by the stairs and go down by the lift. They will go up gradually and then suddenly crash."
"I think the reverse is true for fixed income. We will see yields go higher in steps, the economies aren’t strong enough to take the lift yet."
"When you think about 3 per cent yields for 10-year gilts, that’s probably the average range for the next year, and so for the moment we are at the bottom of the range."
"I am by no means saying that range is going to jump between 3 and 6 per cent, but more likely between 3 and 4 per cent. We are a long way away from normalisation."
Cunningham’s £85m Newton Long Corporate Bond fund is the third best-performing portfolio in the IMA Sterling Corporate Bond sector over 10 years, with returns of 82.36 per cent, almost 30 percentage points ahead of the sector.
The fund also sits firmly in the top quartile over three and five years.
Performance of fund vs sector over 10yrs
Source: FE Analytics
However, Cunningham admits that he is fairly constrained in his Newton Long Corporate Bond fund, which could make the next few years slightly trickier.
He says that his fund is geared towards institutional money such as pension investors who want exposure to investment grade credit for their asset allocation. Because of that, he does not deviate far from the ML Over 10 Years Investment Grade Index and so holds many bonds with a long duration.
However, in his Newton Global Dynamic Bond fund he has a far more flexible investment remit.
In that fund, his duration is just two years with more than 63 per cent of the portfolio’s holdings maturing over the next three years.
However, the manager has actually added duration to his fund recently as he and his co-managers felt the market had overreacted to the threat of higher interest rates. Cunningham says that for the time being, the major risk isn’t necessarily surrounding interest rate volatility.
"At the portfolio level, there is obviously the concern that yields can go higher and spreads won’t be able to rally enough."
"The other risk though is more idiosyncratic, which is the worry that you are holding a bond of a company that used to be two times leveraged and then that moves to six times leveraged. That’s the risk."
Cunningham says that the major worry for bond-holders is that company management teams will start to become more equity friendly and start spending on capex and M&A as the general economic environment improves. This means they could take on more debt.
However, he says it is too early to say whether or not that will happen.
"We’ve long been of the view that the odd bit of volatility can be good for investment grade credit-holders as more risk can mean management teams think twice about gearing up," he explained.
The £925m Newton Global Dynamic Bond fund sits in the IMA Targeted Absolute Return sector.
Since its launch in April 2006, it has made a positive return in every discrete calendar year except for 2011. However, it only lost 0.13 per cent in that 12-month period.
That means, in terms of cumulative performance, the fund has returned 54.8 per cent since its launch and has considerably beaten its LIBOR 1 Month Plus 2 per cent benchmark.
Performance of fund vs index since April 2006
Source: FE Analytics
The fund requires a minimum investment of £1,000 and has an ongoing charges figure (OCF) of 0.99 per cent.
