Pessimism on interest rates and concerns over inflation coming back in the future have led Jim Leaviss, manager of the M&G Global Macro Bond and head of retail fixed interest at the group, to shorten the duration of his portfolios. .png)
“It’s just a general weighted average of the interest rate risk in the portfolio and it means that one doesn’t think that there’s a lot of upside in owning a government bond anymore,” he said.
Government bonds have shot higher over recent years, particularly in 2016, when concerns over a potential slowdown in China were followed by the surprise Brexit vote in June.
Performance of gilts vs equities in 2016
Source: FE Analytics
So far in 2016, gilts have risen 13.57 per cent outperforming equities by 2.36 percentage points, while the yield has fallen to, in some cases, negative rates.
Earlier this year, in response to the Brexit vote, the Bank of England slashed interest rates in the UK to 25 basis points and increased its QE program.
Elsewhere, the Federal Reserve has so far refused to raise rates this year, while other central banks including the European Central Banks have kept interest rates low in an effort to (among other things) stimulate inflation.
As a result, Leaviss is shortening the duration of government bonds within his portfolio, as he believes we are now through the worst of the deflationary pressures seen over recent years.
“Generally a government bond might have an interest rate duration of eight or nine years for a typical bond market. So having a duration of two years means you’re quite pessimistic on the outlook for interest rates and indeed down the future that inflation will make a comeback,” he said.
“If you think about this time last year we had the oil price halving and then halving again, we had fears that Europe was going back into a terrible deflation and lots of things around world – China in particular – that were quite disinflationary, but a lot of those pressures seem to be ebbing now.”
“There are better opportunities for a bond investor out there including credit and including inflation linked bonds - so that’s what we’d rather take advantage of.”
One area he suggests buying is inflation-linked bonds, as he says the market has mispriced inflation in many markets. 
However it is important to note that Leaviss (pictured) does not see inflation making a significant comeback, just more than the market is pricing in.
“There’s obviously still downward pressures or static pressures on prices there’s still a bit of absence of global demand and we’ve not yet seen wage growth take off but certainly we’re seeing a stabilisation of inflation,” he said.
“If you look around the world at the moment, in the US the market is pricing in inflation of less than 1.4 per cent over the next five years while in Europe it’s pricing in inflation of 0.75 per cent.
“It’s only really in the UK, which is pricing in 2.6 per cent over the next five years, that you’ve got anything that looks relatively sensible - so the market is pricing in a very pessimistic outlook from here on in for bond markets.”
As such, Leaviss says he has been adding inflation-linked bonds to his portfolio, which have so far risen 21.87 per cent this year, as the graph below shows.
Performance of index in 2016
Source: FE Analytics
“We’re not saying that inflation is going to make a rapid return but certainly we’ve probably seen the lows for this cycle (or we’d hope that that’s the case) and when wages start increasing then you could start seeing a vicious cycle,” he said.
The manager of the $1.8bn M&G Global Macro Bond fund also sees value in credit, though he has been selling some recently following the strong rally this year.
Prices rallied after the European Central Bank and Bank of England announced quantitative easing measures which included the buy-back of corporate bonds, sending the price rocketing this year.
“When it comes to credit what we think about is are you being compensated for default risk in your portfolio,” Leaviss said, adding that at the moment “it is relatively attractive”.
“And obviously there are some issues around liquidity – they’re less liquid than government bonds and we may be wrong about default rates, but certainly on the face of it corporate bonds offer a decent risk premium.”
Having said that, he says the fund has “taken off a little bit of credit risk” despite remaining high on the asset class fundamentally.
The M&G Global Macro Bond fund has been a consistent performer, sitting the second quartile among its peers over one, three and five years, while over 10 years it has been a top quartile performer.
Run with deputy manager (and FE Alpha Manager) Claudia Calich, the fund has a 1.56 per cent yield and an ongoing charges figure of 0.81 per cent.
Performance of fund vs sector over 10yrs
Source: FE Analytics
The fund has returned 121.92 per cent over the last 10 years, beating the sector average by 35.29 percentage points, while ranking in the top quartile for monthly volatility over the period.