George Luckraft's ABN Amro High Income fund tops the sector with returns of 40.27% for the three years to July 2001
All funds in the UK other bond sector that post three-year records have posted positive returns for the three years to July 2001.
These returns vary from more than a 40% rise to as low as 1.75% for the three-year period, although the volatility in the sector has remained relatively low, with beta figures ranging from 1.16 to 0.57.
The ABN Amro High Income fund, managed by George Luckraft, director at the group, has returned 40.27% for the three years to July 2001, compared to a sector average of 16.73%.
More than doubling the returns of its peers, the fund is ranked first over the three-year investment period and has an alpha score of 9.22, compared to the sector mean of 1.52.
This outperformance, however, has not come at the expense of greater volatility as Luckraft's fund posts a well-below average beta of 0.63. The portfolio currently has a 39.2% weighting in corporate bonds, 4.7% in equities, 5.2% in cash and the balance in convertibles, according to Luckraft.
The high 50.9% weighting in convertibles is normal for the ABN Amro High Income as Luckraft's preference is to always maintain a high weighting in the asset class. He attributes some of the recent success of the fund to this exposure to convertibles.
He said: 'We always try to buy them below par in order to give us some additional capital upside and sometimes the underlying equities perform well. A few of the ones we bought have performed very well and have since been sold or taken over but there is now much less of a supply.'
Luckraft is beginning to position the fund to gain more exposure to corporate bonds. He said: 'We are concentrating on the higher credit end of the corporate bond market. For cash flow reasons, we are continuing to hold some convertibles but we feel the spread between corporate bonds and gilts will narrow. We are acutely aware that we do not want to take on too much risk, which is why we are concentrating on the higher credit-rated corporate bonds.'
Another reason for the outperformance of the fund over the past three years has been its exposure to equities. Luckraft said: 'We hold some high yield equities but these never make up more than 10% of the portfolio. This has added to the yield and capital performance of the fund. Some stocks have been really strong recently and now high yields are becoming more difficult to find.'
Luckraft is very underweight telecoms, holding only Telewest in the portfolio. He said: 'At some stage we will begin to look again at telecoms and increase our exposure but we currently remain cautious on the sector.'
The LeggMason Investments Monthly Income has a three-year return to July 2001 of 23.46%.
It too has outperformed the sector average but not at the expense of greater volatility, posting a below average beta of 0.57 and an above average alpha of 4.68.
When the fund was launched in 1998 it had five things to achieve, according to Chris White, director at LeggMason Investors. He said: 'We always want to pay monthly income, protect or grow capital, have a top-quartile return and running yield and low volatility at around the bottom quartile.
'We have achieved all these things apart from being top quartile in running yield. This is because there has been a proliferation of high yield bond issuance, which has meant we have been slightly pipped to the post. However, we maintain that you take more of a high risk premium with those sort of bonds, whereas we have kept volatility at a low.'
One reason for the low volatility in the fund is that it is invested mostly in short durations. White said: 'We had strong performance over the past 18 months, driven by short duration bonds and convertibles, which have been strong. Value-oriented companies helped as investors made the move to value rather than technology.'
He added that he does not only look at the UK other bond sector but also compares the fund to the gilt and corporate bond sectors. He said: 'We not only invest in fixed interest but also in a range of asset classes, including convertibles, international bonds that are hedged back to sterling, some preference shares and some equities. Preference shares only make up a small percentage of the portfolio.'
The fund is broadly weighted 22% in convertibles, 35% in international bonds, 30% in UK fixed interest, 6% in preference shares, 4% in equities and 3% in cash.
Within the different asset classes, there have been some distinct themes over the past 12-18 months, according to White. He said: 'Technology hit the high-yield market hard, as have the fears about a coming recession. There has been a flight to quality and the bonds section of the portfolio has been fairly defensive.
'It has had a major exposure to financials, non-cyclical service and utilities. Within fixed interest, the credit average has been single 'A' and the average bond duration is 5.6yrs, compared to the FTSE average of 6.5yrs.
'We are in a low interest rate and low inflation era. However, we believe the threat of inflation is more perceived than real, even though the Federal Reserve has taken a chance with inflation by reducing interest rates sharply. The bad news for us is that it is difficult to see bonds making the same progress as they have over the past few years.
'Long gilts have yields of around 4%, which offers no real value, and it is too early to invest in high yield bonds as there is uncertainty over technology and telecoms. In the short term, there is the possibility that the next interest rate move will be up, which also points to a much quieter second half of the year.'
Regression analysis: Regression statistics can be used to compare the relationships between funds, markets or a specific benchmark index. They do not make the assumption that the variables (funds) are related as cause and effect, but permit them to be influenced by other variables (markets).
Alpha: The Alpha describes the theoretical reward obtained by one investment when the second investment has a zero return. To calculate the Alpha, the returns of each are taken and compared together to identify their relationship. This reveals relationships between investments in both bull and bear markets. When applied to portfolios, it can be considered to be the return over and above (or below) the market through portfolio strategy. Good managers have a positive Alpha.
Beta: The Beta is the amount the first fund moves when the other moves by one unit. Beta is a measure of relative volatility (absolute volatility is calculated by standard deviation).
If one fund always goes up and down by 1.5 times of the performance of the index, its Beta will be 1.5. This implies that if the return of the index is positive, then 1.5 times this positive return can be expected of the fund. If the index goes up (or down) 10%, the fund goes up (or down) 15%. Beta represents the volatility of the first investment versus the second. It is only an estimate and to be accurate there has to be a perfect correlation between the two investments.
Correlation: Correlation shows the strength of a linear relationship between two funds. A perfect correlation is when the investments behave in exactly the same manner. A perfect positive correlation is represented by 1, perfect negative correlation by -1 and no correlation with a 0. A perfect negative correlation suggests that for every 1% movement by the index we would expect to see -1% movement return on the fund and vice versa. This is an important factor when using modern portfolio theory.
R-squared: The R-squared indicates the level of movement that can be ascribed or determined by the movement of an index. When the R-squared equals 1 there is a perfect correlation between the investments ' 100% of the movement in a fund can be determined by the movement in the index. When the R-squared equals 0, there is no correlation between the investments. An R-squared between 0.7 and 0.99 suggests that between 70% to 99% of the movement in our fund could be explained by the movement in the index. Below 0.3, there is effectively no influence.
Monthly volatility (or standard deviation): Standard deviation is a measure of absolute volatility. It is the measure of the square root of the variance of each monthly return from the mean. The larger the figure, the higher the volatility of a fund and thus its risk. A typical example of the kind of funds and their associated risk ranging from low risk to high risk are: cash funds, fixed interest funds, balanced funds, UK equity funds, overseas equity funds and warrant funds.
Source: Standard & Poor's
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