Euan McNeil, co-manager of the £765.3m Kames Investment Grade Bond fund alongside Stephen Snowden, says the aim of the fund is to outperform the IMA Sterling Corporate Bond sector.
The portfolio invests predominantly in investment grade and government bonds, and may hold a maximum of 20 per cent in high yield bonds.
The managers have notched up several years of outperformance, propelling it into the Investment Adviser 100 Club 2013.
Process:
Mr McNeil explains that Kames Capital employs a process called the “six key sources of alpha” to manage all of its portfolios, which are asset allocation, duration management, curve positioning, sector allocation, ratings weightings and stock selection.
He elaborates: “So we seek to alter the portfolio’s duration positioning, its curve set-up, its asset allocation and, from a bottom up perspective, we strongly believe in the principle of active investing with relatively concentrated portfolios, so stock selection, sector positioning and ratings are a further driver of performance. I think it’s fair to say that duration and stock selection would be the two key drivers and would probably account for at least 70 per cent of outperformance.”
Mr McNeil continues: “The biggest consideration for us on the macro front at the moment, and at all times really, is the duration management of the fund and the strength of the UK economy. Our belief that gilt yields are stretched leads us to position the portfolio with what we think is a short duration position relative to our competitors.”
To put this into context, he notes that the duration of the portfolio is currently 4.9 years which is “as low as it has been at any time in the past three years”. At times, the duration of the fund has been above seven years in that period. “In terms of what’s driving that belief, clearly the economic data in the UK has been incredibly robust and we believe the consensus for when the Monetary Policy Committee (MPC) will start to raise rates is arguably too late,” he says. “We think if the data continues to be as strong as it has been then the MPC may be forced to review their dovish stance and tighten monetary policy sooner than the markets expect.”
Performance:
The fund has clocked up a top-quartile performance over one, three and five years, according to FE Analytics. In the five years to May 20 2014, it has returned 68.91 per cent to investors, compared to the IMA Sterling Corporate Bond sector average of 55 per cent.
Mr McNeil credits the top down and bottom up approaches with driving outperformance in the portfolio. He points out that the size of the fund, which has roughly 135 holdings at the moment, means that when it does own bonds they like to own them at enough of a size that they contribute to performance. He adds that “selective involvement” in new issues and a focus on rotating existing exposures had been and will continue to be the focus for this year.
“For example, one of the fund’s largest holdings is the new 100-year EDF deal. As the first 100-year sterling deal to come to market, we felt there was an attractive new issue premium for investors, and the subsequent performance of the bond (it has tightened by approximately 85 basis points since launch in January) has been extremely beneficial to performance,” says the manager.
Mr McNeil acknowledges that the “nature of the beast” over the past three years means that performance has been affected by what the fund has not owned, as opposed to what it has, and admits it might have had more exposure to peripheral Europe.
The manager’s outlook comes back to his view that gilt yields are stretched and this is what he calls the “cornerstone” of how he wants to continue running the portfolio.
“With limited interest rate risk and an attempt to protect investors’ capital from what we think will be an upward trajectory for gilt yields against a backdrop where the global economic recovery continues and is particularly pronounced in the UK,” he adds.
“To give you some numbers, 22 per cent of the portfolio is in collateralised and 19 per cent is in the banking sector and we think those two sectors probably provide the most attractive opportunities and will continue to do so for the rest of the year.”
EXPERT VIEW
MARTIN BAMFORD, MANAGING DIRECTOR, INFORMED CHOICE
Verdict
“This is a solid corporate bond fund which would make an excellent core holding. The management team of Euan McNeil and Stephen Snowden aim to add value through duration, yield curve, asset allocation, sector allocation and individual stock selection. Unlike many corporate bond funds, this is a quite concentrated portfolio, which might appeal to investors who prefer the more active approach to fund management. There is also more of a global feel to the portfolio than with many other similar funds, although at least 80 per cent of the assets are hedged back to sterling.”
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