The managers of the £1bn Henderson UK Absolute Return fund have said they fear another “taper tantrum” at the end of March as US inflation readings get an artificial year-on-year boost.
Luke Newman, who runs the long/short equity fund alongside Ben Wallace, said he was concerned over the possible impact of last year’s hefty oil price falls dropping out of annualised inflation readings.
Although the price of a barrel of Brent crude has continued to decline in recent weeks, to less than $30 a barrel, oil’s long plunge began with a 50 per cent tumble in the 12 months to March 31 2015.
As these figures gradually fall out of year-on-year comparisons, Mr Newman warned the US Federal Reserve’s December decision to raise its interest rate could take on a new tone.
“At the end of the first quarter the largest oil falls will start to be annualised. Core inflation [in the US] will mechanically be 100 to 150 basis points higher,” the manager suggested.
US core inflation stood at 2.1 per cent in December, its highest level for more than two years.
“Normally I wouldn’t be worried, but in a volatile market you may have people saying, ‘the Federal Reserve has been too slow [in hiking rates] it’s a policy error’, and bonds selling off.”
Mr Newman added: “We are worried we could see something similar to the taper tantrum,” he said, referring to the May 2013 episode where then-Fed chair Ben Bernanke sparked a bond sell-off by stating the central bank would soon begin winding down its quantitative easing (QE) programme.
But despite this possibility, the Henderson managers said they were “increasingly thinking we can understand current market moves”.
Mr Newman said that while volatility was elevated, so too was the dispersion of returns between individual stocks.
As a result his biggest concern is not China or market direction, but the potential for a return to a period of low dispersion – though he suggested there was a “low risk” of this happening.
The oil price slump was one development that was providing opportunities, the manager said.
Mr Newman said he was “really concerned by the lag in the supply base”, a delay which pointed to shorting the suppliers of oil and gas firms.
This idea could ultimately take the form of a pair trade with BP or Shell on the long side, he added.
“Once Shell has completed its deal for BG, that [trade] could be interesting, particularly as we move into the period where dividends are paid.”
Pair trades have formed an increasingly significant portion of the Henderson UK Absolute Return portfolio of late, having not been used at all as recently as five years ago.
The managers now have more than 10 per cent in such strategies, a move that was partly “a function of how uncrowded our space is” when it came to derivative trades, Mr Newman said.
“We are not being crowded out as we used to be. It feels like we have a lot longer to make these trades. [But] I am not sure how long it will last. I’m sure the big multi-strategy hedge funds have started to notice.”
The manager also identified a number of opportunities on the long side.
He said particular areas of interest were companies that were able to grow their dividends, online gambling and gaming firms, potential merger and acquisition participants, and the yield curve steepener trades that would benefit in the event of another taper tantrum.
INFLATED FIGURES?
2.1%
US core inflation reading in December 2015, the highest since July 2013
100-150bps
Predicted US core inflation rise due to oil price falls dropping out of comparison period
