Standard Life Investments’ (SLI) absolute return bond team has vowed to stand by its bet on US and UK bond yields rising in spite of trades that have hit fund performance.
SLI’s Absolute Return Global Bond Strategies fund currently has ‘short’ positions on US and UK government bonds through derivatives, effectively betting that government bond yields in both countries will rise.
The increase in bond yields is inversely correlated to the value of the bonds, so when yields rise, existing bonds fall in value.
However, the positions, known as ‘negative duration’, have hurt the performance of the fund so far this year as government bond yields in both the US and the UK have fallen sharply.
SLI said the negative duration positions were among the biggest detractors from the fund’s performance in the third quarter, but the team has decided to stick with the strategy.
Sebastian MacKay, co-manager of the Absolute Return Global Bond Strategies fund, said “there is not much benefit” to having a long position on government bonds with yields “at these levels”.
He said the risk/reward trade-off now favoured investors who had positions in their funds which would benefit if yields rose.
The overall duration on the whole portfolio, which measures the vulnerability of the portfolio to a rise in interest rates, is currently between negative 1 and negative 1.5.
This means the portfolio as a whole should gain money when interest rates and government bond yields rise.
Mr MacKay said he was “confident” government bond yields would rise from their current levels in the next 18 to 24 months, so he expected the trades to make a positive contribution to the strategy in that time horizon.
In spite of the headwinds from the position, the SLI fund still managed to deliver a positive return in the third quarter of this year, and is currently up 2.4 per cent so far this year, beating the return from cash but not its cash plus 3 per cent benchmark.
The recent positive performance has been driven by the fund’s large bet on the strength of the dollar, which has generated returns as the greenback has appreciated against most currencies in the past few months.
Three of the top-four contributors to performance in the third quarter came from the fund’s dollar positions, as it gained in value against the euro, the Canadian dollar and the Australian dollar.
The SLI team also closed out its position betting on the strength of the dollar against the Japanese yen in the third quarter, following a strong period of returns from that position.
The closed dollar/yen position was one of a large number of bets on the Absolute Return Global Bond Strategies fund that were closed in a busy month for the team.
The fund’s bet that US rates would rise sooner than UK rates was closed as the outlook for the bet deteriorated, while the team also booked the profits gained on a bet on rising volatility in sterling after the Scottish referendum.
