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By By Bradley Gerrard | Published Feb 21, 2011

Bond fund managers take inflation action

Consumer prices index (CPI) inflation was reported at 4 per cent for January and the Bank said rates could be hiked from their current all-time low of 0.5 per cent, where they have now remained for almost two years, to 1 per cent by the end of year.

This is dire news for bonds as when inflation expectations rise bond yields rise across the yield curve, as investors demand better returns to offset the effects of the inflation. When bond yields rise their prices fall.

John Pattullo, co-manager on Henderson Global Investors' £970.6m Strategic Bond fund, said he is shfting into , subordinated financials and secured loans and avoiding gilts and investment- grade holdings to avoid the possible rate hikes.

He said: "There is too much latent money sitting in investment grade.

"The question is whether it is permanently there and whether it should be heading to high yield or equity funds.

"We were heavy on investment grade but we aren't now as we are in the reflation camp.

"We would have a different looking fund if we were worried about deflation."

, co-manager on Artemis' £500.3m Strategic Bond fund, said he feared the Bank was beginning to get "behind the curve" in terms of rates and so could raise rates excessively.

He said: "Mervyn King is beginning to loose the plot in terms of inflation, which is gathering steam.

"He should be raising rates and he isn't. He is letting inflation become ingrained in expectations and once this happens inflation tends to follow."

Mr Foster, whose fund has delivered a top-decile return of 26 per cent over five years compared with the IMA Sterling Strategic Bond's 12.9 per cent, said he was concerned about investors in investment-grade funds.

, head of credit at Gartmore, said as inflation is being driven by external forces so there was "no point" in raising rates now but added if they did rise, gilts would "suffer".

He said: "There is no value in gilts at the moment as their real return has a minus sign at the start.

"If you hold on to them in the hope inflation will fall that is a call you have to make.

"But Mervyn King said we are not going to be back to the 2 per cent inflation target for a few years, which would give roughly a 1.8 per cent real return even if inflation gets back to that level."

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