jim leaviss' m&G gilt and fixed interest fund ranks 5 out of 26 funds by seeking out value in the shorter end of the market
The AA-rated M&G Gilt and Fixed Interest fund is currently enjoying the largest volume of inflows during manager Jim Leaviss' five-year tenure.
Leaviss, head of retail and institutional fixed interest at M&G, said the asset class has really come to the fore after the past three years outperformance of equities and he expects this trend to continue.
Backed by a team of ten gilt specialists and 27 credit analysts, he has steered the fund to top-quartile performance over one and five years.
Over three years to 1 November, the fund posted growth of 12.5%, offer to bid, compared to a UK gilt sector average return of 8.6%, ranking the fund 5 out of 26.
Is the bull market in bonds starting to unwind?
No, not at all. It has been another very good year for corporate bonds, gilts and international bonds.
If you look back at relative performance against equities, bonds have now outperformed for 12 years and at a much lower level of volatility.
Certainly from what we have seen, individuals do not have enough bonds in their portfolios.
A number that surprised me, given the amount of coverage fixed interest has had in the press over the last couple of years, was that the average client in the Pep and Isa market only has 7% in bonds.
Pension funds on average only have 18% of their funds in fixed interest when really that should probably be 100%, given the developments in FRS 17.
So demand for the asset class remains strong?
Some pension funds like Boots now have 100% in bonds and others like Granada are doing similar, so there is still lots of demand.
The great performance we have seen over the past decade is down to the low inflation environment we have been experiencing. Given that we are still in a low inflation environment, there is no reason why fixed interest cannot continue to outperform, since inflation is the enemy of bonds.
Do you expect further domestic interest rate cuts?
I imagine we have not seen the last UK rate cut. The UK is different from the US and Europe in that it never really went through the recession that they did. It has got slower growth than one or two years ago, but recession looks a long way off in the UK.
Nevertheless, the fact the UK is growing below trend does not mean that inflationary pressures are likely to emerge and I think the MPC is worried about the global environment as much as the UK environment.
UK manufacturing has been down in the dumps for a long time, but the service sector continues to perform reasonably strongly. The MPC is not particularly worried about the UK. What it is really worried about is the global environment and any potential shock to the global system that would send the UK down.
The UK consumer does have a lot of debt and we are nearly back up to the level of the late 1980s in terms of how much people are borrowing relative to their salaries. If unemployment started to rise, then you could see a very nasty shock to the UK economy because of these debt levels. The MPC will therefore play on the side of caution, but they will not be worried about the UK economy in the same way Greenspan is about the US economy.
Has this month's 50 basis point cut in the Fed rate impacted the gilt market?
No, many people do not expect further UK rate cuts, so there is the potential for the market to be surprised. Indeed, a lot of people think rates will go up next year.
Have these expectations altered your positioning of the fund?
No. I have been bullish on the UK gilt market for some time now and think that the low inflation, low growth world, coupled with the arguments I have talked about in terms of the demand for fixed interest, makes it a good place to be. Another important factor many people do not look at when they see the yield of 4.5% on a gilt is the return they are getting.
If you go back to 1980 the same gilt was yielding 14%, but in those days inflation was running at 15% so you actually lost some of your money every year.
Nowadays, although the headline yield is a lot lower at 4.5%, because inflation is so much lower, UK headline inflation is below 2%, then there is value there and you can earn an attractive real yield.
Given gilts are offering a real return in difficult equity market conditions, why do you think the average investors' fixed interest exposure remains so low?
If I had to guess, maybe a lot of Peps and Isas sold to people were technology or in higher risk equity funds during the equity boom.
Dividend and income funds are coming back into fashion now though and I think people have hopefully learned the lesson of diversification over the past few years. If you do have a mix of bonds and equities, you won't get something that will give you the highest return in any one year, but it will smooth out the difference between equity and bond performance and provide income.
I think many people are going to be more conservative in how they invest going forward after getting their fingers burned, so I would be very surprised if that 7% figure ' the amount an average Pep or Isa client has in bonds ' stayed that low for long, although the change won't happen overnight.
What is the investment process behind the fund?
The way I have always run this fund is to take a medium-term view on the macroeconomic and demand issues, so I am not taking big positions in any one bet. There are three ways you can add value in a fund like this. First is duration, which is really a market direction bet, second is positioning on the yield curve and finally adding credit to the portfolio because you can have up to 10% of the portfolio in corporate bonds.
Another way you can add value is through trading heavily, but it just adds to your turnover and is not my style. I am very much a medium-term investor.
How is the fund positioned at the moment?
In the first case, I have a long duration position because I like the gilt market. On the yield curve, I am slightly bearish on the very long end of the gilt yield curve and think there is better value at the shorter end, but not necessarily the very short end.
At the moment though, given how expensive AAA and AA-rated corporate bonds are and the fact this is a blue chip fund and cannot invest in lower rated corporates, I do not think there is particularly good value there so I don't have any corporate bonds.
I cannot see a trigger for AAAs getting particularly cheap unless there is a global financial crisis, because AAA and AA spreads tend to be linked to the swaps market and the rate at which banks lend to each other.
For example, during the Russian crisis we saw a big increase in that spread, but that is not a core scenario.
That's not saying the overall corporate bond market is overvalued, there is good value among A and BBB-rated bonds, but they are more for Anna Lees-Jones' Corporate Bond fund.
How many holdings have you got in the fund?
I have 14. You don't need many holdings in a gilt fund because you do not need that diversification of credit because it is all the same issuer, Her Majesty's Government.
Is the possibility of the UK joining the euro a scenario you have looked at?
We have looked at that as a trade idea and a number of institutional funds have taken bets out of gilts into German government bonds, for example.
Long-dated German bonds were yielding more than gilts and a lot of people did that trade expecting the UK to join the euro, so it wouldn't matter what you held.
I think the vibes we have been getting from the Government over the past six months are not supportive of the euro. That is probably pragmatism on the Government's part.
If they cannot win a referendum they are not going to have one. We all know Tony Blair would like to go into the euro, but its on the backburner. We get the results of the economic tests sometime next year and they might well say we would like to go in but now is not the right time. It is going to be a hard sell.
Is the UK economy likely to be sucked into a deflationary spiral like Japan?
There is a reasonable chance we will experience deflation, but it is not my core scenario. The MPC is predicting inflation of just below 2.5% for the next couple of years, so it is not their core scenario either.
If you look at the UK there are 80-odd components that make up the inflation statistics and about 30 of those are actually already in deflation.
For instance, clothing and footwear is falling by about 5% a year, so deflation is already happening in certain sectors, so there is a risk. Certain sectors, such as services, are experiencing inflation though.
The good things about the UK and US that should stop that happening is that we have much more flexible labour markets, so we can make people in unprofitable industries redundant and find them something more productive to do.
In Japan there are still lots of people who are employed but not adding anything to the economy and bad companies do not close down.
There is a trend over the past 20 years or so of lower and lower inflation and we are getting down to level where there is a real risk of deflation. In such a situation you should invest in a gilt fund, but it will not be good news for any other asset class.
FUND MANAGER: Jim Leaviss
Leaviss joined the Bank of England in 1992 after graduating with a degree in economics from Manchester University.
After moving within the Bank to become a gilt and money market trader for three years, he joined M&G in 1997.
As well as M&G Gilt & Fixed Interest fund Leaviss also manages the group's Global Managed Bond and Real Yield funds.
Set up Vanguard in 1975
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