while equities have had a bear market, the uk other bond sector has posted a rise of 16.03% over the three years to the end of may 2003
The UK Other Bond sector is something of a catch all peer group but one factor almost all its members have in common is the production of real returns over the three years to May 2003.
Indeed, only two funds in the sector, the Exeter Zero Preference fund and the Newton European High Yield fund, posted negative returns over the period.
The increase in demand for fixed interest funds over the last three years is shown in the increase in the number of funds available. Of the 51 funds with one-year track records, only 34 were around three years ago.
Over 12 months the performance of the sector has been more mixed, with a number of funds suffering due to their exposure to zero dividend preference shares which have been hit badly after the split capital crisis.
One such fund is the Exeter Zero Preference fund, managed by Paul Craig, which fell 18.18% over one year to the end of May, compared to the sector average gain of 4.48%. The underperformance is even more marked over three years, with the Exeter fund returning -35.95% against a sector average gain of 16.03%.
However the fund has managed to engineer a turnaround in the past six months, cutting its exposure to investment trusts with high levels of gearing and cross-shareholdings, while boosting its exposure to those with little or no gearing and good underlying portfolios trading at a discount to net asset value. As such, Craig said the fund has posted positive growth of 14.9% over six months to the end of May, compared to the sector average rise of 10.2%.
Added to the changes made to the portfolio, Craig said the performance of the fund has also picked up as a result of the fact that many of its larger holdings are now providing some of the strongest performances in the sector after earlier being severely marked down.
For example he said the funds largest holding, Murray Global Return, rose 22% over the past six months, outperforming both the zero sector and the broader equity market.
He added: 'This in part reflects the savageness of the sell-off as split capital trusts struggled through what had been one of the worst periods in stock market history. Consequently, zeros in most cases have provided steady shelter for much of the last six months, while the broader equity markets demonstrated extreme volatility.'
Looking forward however, he conceded that the share prices of most zeros are likely to reflect the mood of the broader equity market. Consequently he said any further uncertainty in the underlying equity market is likely to frustrate the short-term performance for the majority of zeros.
However he added that this does not necessarily make zeros any less attractive since many are still trading at a large discount to NAV, although he said investors will have to be patient.
George Luckraft, manager of the Framlington High Income fund, has had no such problems with splits, as his fund focuses on convertibles, corporate bonds and some high yield equities.
As such his fund, which he took over in September last year, is up 4.79% over 12 months and 16.89% over three years.
Since Luckraft took over the fund it has grown from £27m to £49m, which has enabled him to increase the number of holdings in the fund from around 60 to 81, as he felt it was too concentrated.
With a lack of new issues in convertible bonds over the past four to five years, Luckraft said he has reduced the fund's exposure to convertibles from 55% to 40% and the most favoured area in the portfolio is now corporate bonds, which constitute 52% of the assets.
Convertible bonds are fixed coupon securities which have a set redemption date but have the right to convert into an ordinary share.
Luckraft said there have been some signs these bonds are coming back to life, with the announcement of two issues last week from Scottish Power and Cable and Wireless and more on the horizon.
The 52% of the portfolio invested in corporate bonds is predominantly at the bottom end of the investment grade band, with some sub-investment grade bonds.
He said: 'You have to go sub-investment grade at present as investment grade paper is so strong currently meaning the yields are not that high, a reflection of the moves in interest rates.'
Unusually, while equities have rallied since March there has also been a rally in bonds, a trend Luckraft said is unlikely to last, tipping bonds to pull back.
He said: 'I think the bond market has gone a bit too far and it could backtrack if we see good US economic data in the next few months.'
George McNeill, manager of the Premier High Income Bond fund, believes most developed market sovereign debt looks expensive.
The overall bond market is likely to suffer in coming months as it looks expensive, he reasons, and because there is now a rising return of interest in equities. He said the fund will look for more affordable debt. He said: 'At present the portfolio has 41.64% in sovereign and 58.36% in corporate debt. Currency risk is infinitely higher than bond risk and as such the fund has to have a maximum of 80% in sterling or hedged back into sterling at all times.'
With financial woes hurting the corporate sector over the last 18 months, McNeill said the key to successful investing is to avoid having too much of the fund in one place. Using global markets, McNeill looks for the cheapest bonds with the lowest risk and by hedging 80% against sterling he said he is reducing the risk element of the fund. Using this process the fund is up on the sector by about 10% over both one and three years, yet it has maintained a beta of 0.4. Over one year the fund has returned 15.51% and over three years it is up 27.29%.
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