The huge rally in UK government bonds in August is likely to be the last hurrah for fixed income investors as yields look set to rise, according to BlackRock’s Simon Blundell.
Mr Blundell, who manages the £300m BlackRock Corporate Bond fund with Ben Edwards, said yields must rise from here, although he said corporate bonds should still be able to make “marginal” gains.
He said he had been reducing his sensitivity to rises in interest rates, known as duration, down to six years from its usual position of between 6.5 and 6.75 years.
Duration measures a fund’s exposure to government bond yields and a low duration is thought to protect capital more effectively when yields rise.
Mr Blundell said this was likely to be a shorter duration position than most of his peer group and reflected his view that gilt yields are likely to rise from here.
Any upward move could cause corporate bond yields to rise too, pushing down prices and leading corporate bond managers to lose money.
The consensus view at the start of 2014 was that bond yields would be set to rise as the UK seemed to be on the path towards economic recovery, which was expected to lead to the Bank of England raising its base interest rate.
But so far this year, government bond yields have rallied instead, surprising many managers.
The market rallied particularly strongly in August, with 10-year UK government bond yields dropping by 25 basis points. The securities now yield 2.46 per cent.
Having performed in line with the sector so far this year, the BlackRock Corporate Bond fund suffered in August due to its lower duration position.
Mr Blundell said the yield drop was a “huge move in a one-month period” and helped drive the performance of funds with more exposure to government bonds.
However, Mr Blundell said he now expects bond yields to rise through to the end of the year and predicted “marginally” positive returns for his fund for the rest of 2014.
He said credit spreads, the difference between government bond yields and corporate bond yields, should tighten, meaning that corporate bond yields will not rise, or not as much as government bond yields.
This credit tightening will offset the rise in government bond yields, cancelling each other out and leading to neither a gain nor loss of capital for the sector.
He said such tightening was supported by both fundamental and technical factors.
He cited the “supportive action from the European Central Bank” and the “severe lack of issuance in sterling” (which means supply is not meeting demand) as two reasons why spreads could tighten.
Mr Blundell is favouring euro-denominated debt within his fund, although any currency exposure is hedged back to sterling.
“With the supportive central bank in the eurozone, this is a sensible trade to have on,” he said. “The ECB is very much in play and looking to support the market.”
