A Monthly Publication

By Robin Sainty of IFA Corporate Ltd

 2009 was a banner year for fixed interest funds with quite extraordinary returns, which are unlikely to ever be repeated. I predicted in my end of year analysis that the fixed interest market was overheated and that a significant correction was likely. The level of quantative easing carried out by the Bank of England was not good news for gilt funds and corporate bond funds, even those concentrating on the investment grade sector were coming off a year of equity like returns.

So, how does the market look in the second quarter of 2010? Well, there is still value to be had, but, unlike 2009, when virtually everyone made good profits, there is a need to be much more selective going forward. Bank debt has performed extremely well, and the level of default risk in the high-yield (i.e. sub investment grade) market has declined significantly. Moody’s (one of the most respected credit rating agencies in the world) reported a default rate of 10.2% (i.e. an expectation that 10.2% of companies issuing loan stock in that sector would default on their repayments), but their baseline forecast is for the rate to drop to 2.7% by the end of this year. This means that there are still good opportunities even after the strong rally of recent months. However, the easy money has been made and we are seeing the market settle down to something like the pre crisis levels that we saw in the first quarter of 2009.

Low interest rates and subdued inflation are likely to remain supportive of the fixed interest market. Paul Causer of Invesco Perpetual, one of the foremost companies in this market, has said: “With a large output gap as well as high unemployment, the UK is a long way from having an inflation problem. As a result, I would be surprised to see short term interest rates moving significantly higher in 2010.” This, of course, is not such good news for cash savers!

The fact is that there is value in the market, but that finding it is a job best left to the experts, so the funds to look out for a “strategic” or “tactical” bond funds. These are funds, which allow the managers a large amount of discretion in terms of where they invest, both in global and market terms. Generally speaking the most attractive funds will be those, which give their managers the widest possible scope. For example some funds which are labelled as “strategic” actually have relatively limited investment scope, so “looking under the bonnet” is essential. What you should be looking for is a fund, which is able to alter its asset allocation quickly with an ability to be fully invested in cash or near cash assets when markets are adverse.

Global exposure is important simply because the world is shrinking as it becomes more inter-connected, and it becomes increasingly difficult to escape situations where events elsewhere have an impact on a predominantly domestic portfolio. This fact opens up a whole range of both threats and opportunities and to get the best results it’s wise to have as many tools in your tool box as you can muster. An excellent example of the importance of this can be seen in the relative performance of the six fixed interest funds in the absolute return sector where 12 month returns range from –1.1% TO + 11.3%.

However, it is important to appreciate that fixed interest funds do carry risk and that they will fall as well as rise. Consequently, just like equity funds, short-term investors should not use them. However, they are unlikely to have the same level of volatility as equity funds over longer periods, so will continue to appeal to the more cautious investor who is exasperated at the pitiful returns that continue to be available on cash deposits. Once again, though, closer inspection of the investment approach of the managers is vital, as some funds will have significantly different risk/reward profiles to others.