Fixed Income  

Jolly favours going short on the US and long on Europe

Schroders’ Bob Jolly has said he may add to his short positions on US interest rates on the view the economy will be the first mover in raising rates in the developed world.

Mr Jolly, who manages the group’s £242m Absolute Return Bond fund along with Gareth Isaac, said a key position in the fund had been a long position in European interest rates, based on the view they would keep falling, and a short on US and UK rates, believing these will rise.

If bond yields increase, prices fall, which means bond investors lose money. But a short position bags a manager profits if yields rise.

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The Absolute Return Bond fund has strongly outperformed its three-month sterling Libor benchmark since Mr Jolly and Mr Isaac took it on. According to data from FE Analytics, the fund has delivered 11 per cent since they began managing it in November 2011, which is above the 1.6 per cent return by the fund’s benchmark.

However, Mr Jolly acknowledged that there had been a recent dent to the performance of the fund, because of his negative duration stance, which would see the fund benefit if interest rates rose.

The manager pointed out that interest rates would normalise and that he did not want to be “picking up the last pennies” of returns from a positive duration strategy when they did.

Mr Jolly said he was considering adding to his short position on US interest rates. This is because he believes it would be the first mover in terms of interest rate increases.

“Corporate profitability is getting better in the US and there are good reasons why I think the US will be the one where rates go up more than the UK,” he said.

The manager added that the UK would be keen to keep rates low, though, and highlighted that he was “suspicious” of the UK’s supposed economic strength.

“The UK has a fiscal drag,” he said. “That will take the wind out of the economy’s sails.

“As soon as the UK starts raising rates, all that leverage comes back to haunt you.”

Mr Jolly said that with growth remaining weak in Europe, which is the UK’s key trading partner, this would dampen economic expansion in the UK and this would encourage the Bank of England to keep rates low in a bid to maintain some level of economic growth.

“The fact that the gilt market has underperformed both Treasuries and German bunds means for me it is an easier short on the US than the UK,” he said.

Elsewhere, the manager said he had been reducing his exposure to financials partially, but still favoured the sector.

“The story for financials in general is that every central banker wants to make them as boring as sin,” he said.

“They don’t want to repeat the ‘too big to fail’ problem and each piece of legislation coming forward is to make banks more boring – and ultimately credit investors like boring banks.”