Fund manager: Anna Lees-Jones
"At the start of August, I started to position the fund more defensively. Corporate bond spreads were on the tight side so we moved into gilts, cash and AAA debt, such as the World Bank and the European Central Bank (ECB)," she says.
The fund also invests up to 5% in high yield, to give it a bit more diversity.
Long term, certainly for the remainder of this year, Lees-Jones remains positive on the corporate bond market but neutral on gilts. The weak economic situation, she says, has led to increased interest in gilts, with the result that government paper, particularly at the long end of the market now looks increasingly overpriced.
"However, there are a number of positive drivers for the corporate bond market at the moment, narrowing spread compressions. Demand for corporate debt remains stronger than supply, with the increase in demand coming from pension funds and life companies who view the corporate bond market as significantly less volatile than equities. Additionally they also tend to offer a better return than gilts," says Lees-Jones.
The fall in the value of equity assets has increased the mismatch between assets and liabilities, and actuaries have turned to corporate bonds to decrease the mismatch, she adds.
Since 11 September, Lees-Jones has made a number of definite sector plays, increasing the portfolio's exposure to utilities, financials and non-cyclical consumer credits, although overall, she says, the fund is still maintaining a defensive stance.
Her biggest current sector holdings are financials, in which she has 30% of the fund's assets invested and 10% each in utilities and property.
Despite remaining defensive overall, she has also increased her exposure by about 5% in more opportunistic areas such as telecommunications and consumer goods.
"There are a lot of individual companies that have seen their spreads widening for no other reason than negative market sentiment about the sector in which they operate. Over the last few weeks we've seen opportunities arise in the telecommunications sector and in certain industrials, such as Rolls Royce," says Lees-Jones.
Going forward, she sees a mixed economic picture, with a weakening in growth and demand. The gilt market will remain volatile, she believes, with anything that is a leading indicator liable to rapid turnaround, and a continuation of spread tightening in the corporate market likely.
Yields in gilts, she says, would need to rise significantly before the current balance in the fund between gilts and corporate debt changed. In this kind of environment Lees-Jones will continue to hold a diverse portfolio of around 120 credits.
"The risk of defaulting in this kind of fund means diversification is crucial. You need lots of stock that outperforms a little, rather than a few stocks that outperform a great deal.
"Unlike an equity fund we don't tend to get the large upsides, so we're looking to add little bits of value through punchy performance on individual credits, with no more than 3% of the assets in any one credit," she says.
Lees-Jones does not believe the size of her fund makes it more difficult to manage.
She says: "The fund is one of the largest in its sector and we have had positive inflows this year so it is getting larger. The style in which we manage the fund is quite slow moving. We are taking longer-term decisions that will lead to first-quartile performance over the longer term.The advantage of the size outweighs the disadvantages because we get better allocations and greater transparency with broker books. We can also try and influence new issues because we have so many funds."
Explaining how she selects the high-risk portion of the fund, Lees-Jones says: "About 4% of the fund is currently in high yield and includes names like Energis and William Hill, which is a single B bond. Then we have a couple of double B subordinated tranches of securitised bonds. Companies like British Land and Sainsbury's have securitised their property and the deals initially come at very high levels, 400 basis points over gilts, when triple B bonds are normally priced at 200 basis points over gilts. People were not familiar with securitised bonds so were overcompensated."
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