Snowden, who manages the £765m Kames Investment Grade Bond fund, understands why his asset class is becoming increasingly out-of-favour as the global economy is recovering. He also says that investors are well within their rights to be sceptical about bonds, given how both the sovereign debt and investment grade credit markets have performed over the past 12 months.
Performance of indices over 1yr
Source: FE Analytics
However, Snowden takes issue with the widely-held view that bonds will drastically underperform, or even lose investors a lot of money, over the coming years.
“It’s no surprise, with economies looking stronger, that investors want higher return assets like equities. But, I’d argue that it isn’t a bad environment for fixed income either,” Snowden said.
One of the first misconceptions the manager points to is the belief that inflation will inevitably come through, therefore hitting bond-holders with capital losses.
Like FE Alpha Managers John Pattullo and Jenna Barnard, he thinks that deflation is still the greater of the two threats.
“You can see that inflation has fallen considerably and the belief of those who thought that quantitative easing would lead to an explosion in inflation is wrong; in fact the exact opposite has happened.”
Performance of index in 2014
Source: FE Analytics
“So why hasn’t QE lead to the explosion in inflation like the bond bears would have you believe? Well quite simply, the financial system has contracted materially.”
Snowden says that, following a period of huge credit expansion and an increase in the money supply, banks have had to de-lever their balance sheets considerably after the financial crisis.
He therefore says that, with bank lending growth still at a very low level, there is no obvious catalyst for the prices of goods and services to increase from here.
“There is a lot of slack in the UK economy,” Snowden said.
“The unemployment rate is coming down, which is good news, but the numbers of very flattering. There are a lot of people that are no-longer defined as unemployed and as employed, even though they are only doing a few hours of work a week.”
“I think there needs to be a material amount of permanent full-time job creation before we end up in a situation where labour is actually tight and wage inflation comes back with any vigour.”
“The real problem for bonds was, why would you buy a gilt if you were guaranteed to lose money on a real basis because inflation was higher than yields? That is no longer the case; bond yields are higher than inflation.”
“Again, this does not make gilts look cheap, but it’s hard to say they are particularly out of whack.”
Snowden also believes that investors, and the market as a whole, are wrong about the forecast for future interest rate movements.
In order to kick-start the economy after the financial crash, the Bank of England slashed the base rate to just 0.5 per cent.
Five years on, lots of industry experts – such as FE Alpha Manager Dickie Hodges – have urged investors to start protecting their portfolios against rate hikes, which would negatively affect bond prices, over the next year or so.
However, Snowden says that with 10 year gilts yielding 2.62 per cent, there is still plenty of room to manoeuvre.
“When people realised that growth was returning and that base rates will have to go up at some point, the gilt market sold off. I would argue that we have already priced in a number of rate hikes already,” Snowden said.
“The first base rate rise is expected for February next year. By the end of 2016, the market is pricing 2.25 per cent by 2017 it is pricing in 2.5 per cent. If we get 2.5 per cent base rates there, that’s pretty much where gilt yields are now.”
“I personally thing gilt yields will go higher, but at the same time I think it is unlikely that they will explode.”
However, the manager thinks that future interest rate forecasts also need revising.
Snowden says that the Bank of England will have to tread very carefully with interest rate hikes as they could be in danger of killing of the UK’s economic recovery.
The reason for that, he says, is because 70 per cent of home owners are on SVRs (standard variable rates) and while the average house price in the UK is going up, that increase is not spread evenly across the country.
The manager is concerned that by raising rates to slow down the London/South East housing recovery, they are at risk of “killing all the flowers as well as the weeds”.
“The problem of base rates being at 0.5 per cent for so long is that society gets used, very quickly, to low mortgage repayments.”
“You will see a genuine cost of living crisis when base rates start to tick up and I think consumption in the UK will be very heavily hit quite quickly even with relatively modest base rate rises. No-one really knows what is going to happen until they pull that string.”
“However, it is undoubtedly going to be difficult to see base rates going very high, too soon.”
Snowden began running funds at Kames Capital in April 2000, but left the group for Old Mutual in February 2004.
However, he returned to manage the Kames Investment Grade Bond fund with Euan McNeil in September 2011. According to FE Analytics, over that time the £765m has been a top quartile performer in the IMA Sterling Corporate Bond sector with returns of 26.12 per cent.
Performance of fund versus sector since September 2011
Source: FE Analytics
It has a yield of 3.06 per cent and its clean share class’ ongoing charges figure (OCF) is 0.8 per cent.