Fixed Income  

Kames outbid on ‘favourite’ fixed income asset

The managers of the Kames Strategic Bond fund are struggling to add to their favourite fixed income asset because they claim the prices are far too high.

The fund’s co-managers Phil Milburn and David Roberts said in an update last week that they had been attempting to increase the fund’s 5 per cent weighting in a niche area of US residential mortgage-backed securities (RMBS).

But the managers said they had been unable to secure more of the bonds, which they dubbed their “favourite fixed income investment”.

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The bonds are linked to US mortgages, however they are considered ‘super senior’ bonds, meaning there are several layers of junior bondholders below who would shoulder losses in the event of a default by the bond issuer.

Mr Milburn said that some of the bonds became available in December and Kames had participated in several auctions.

But in spite of putting in what he thought were “full prices”, Mr Milburn said they were “promptly significantly outbid”.

The inability to access the RMBS bonds has been a long-standing issue for the Kames managers as they had been looking to add to their positions throughout 2013.

Mr Milburn said he would continue to seek out more bonds in that area but claimed the “selling activity” has “completely dried up”.

The difficulty in getting access to mortgage-backed securities at a reasonable price reflects the increasing popularity of the asset class as it shrugs off the stigma associated with it after the assets were hit badly during the financial crisis.

While the RMBS assets are the managers’ favourite area of fixed income, most of the assets in the Strategic Bond fund are in investment-grade and high-yield bonds.

Mr Milburn said investment-grade spreads – the difference in yield between them and government bonds – had narrowed considerably and any further movement would be a “slow grind tighter”.

While that tightening would be positive for investment-grade returns, Mr Milburn said the returns from the bonds would mainly be down to the yield in 2014.

The same is true with high-yield bonds, which currently make up 24 per cent of the fund, and from which Mr Milburn expects a return of between 4 and 7 per cent, with little probability of capital growth.

One area in which the Kames team could be active in 2014 is in emerging market debt.

Last year the managers established a small 4 per cent position in emerging market corporate debt, which was hedged against an equivalent negative bet on emerging government debt. If the asset class had fallen, this move would have produced returns for the fund.

They removed the government debt hedge following a tough period for the asset class, however Mr Milburn said there was now a “window of opportunity to make some money” in emerging market debt.

But he said he did not want to commit a “large percentage” of the fund’s assets to this area and would reinstate his negative bet on emerging market government debt if he perceived difficulties in developing countries.