The multi-manager, who joined Liverpool-based Seneca when it purchased part of the Miton Group, said his Diversified Growth fund now only held 14 per cent in fixed income in all specialised areas, including recently added exposure to floating-rate notes and asset leasing.
Mr Callow said both of these sub-asset classes would mitigate capital losses in the event of interest rates rising, something he and co-manager Alan Borrows expect to happen next year.
To implement his call, Mr Callow backed the launch of M&G Investments’ new Global Floating Rate High Yield fund, run by James Tomlins. Seneca was one of the first investors in the fund, and holds a 1.5 per cent position.
The M&G fund invests in bonds which reset the amount they pay out every three months to reflect any rise in the Libor rate.
“As rates go up, the value of the coupon will rise,” Mr Callow said. “That mitigates capital losses.”
Mr Callow also said the holdings in the new M&G fund had “virtually zero” sensitivity to rises in interest rates, something which usually erodes returns from bonds.
“We have made this asset allocation call because rates are likely to rise, and in the UK we have had two members of the Bank of England’s rate-setting committee vote in favour of a rise,” he said.
He added that yields in many areas of fixed income were now unsustainably low, meaning many bonds were overpriced.
“Fixed income assets have had a remarkable run but we expect that is now set to end,” he said.
Mr Callow said he had also recently backed the London-listed SQN Asset Finance Income investment trust, which started trading on the index in July.
The manager said the trust focused on equipment leasing and asset finance arrangements in the UK and US.
It specialises in areas that are deemed ‘mission critical’ to businesses across a variety of sectors, including agriculture, energy, environmental, medical, technology and transportation.
The trust targets a return of 8-10 per cent per annum, which Mr Callow said provided some protection from rises in interest rates.
The manager owns no government debt at all, having sold his last sovereign debt exposure in the spring.
The rest of his existing fixed income exposure includes two TwentyFour Asset Management funds, which invest in asset-backed securities.
He also owns the Royal London Short Duration Global High Yield fund, which targets higher yielding companies in more niche areas of the market.
Fixed income focus shifts to protect against rate rises and inflation
Simon Callow and Alan Burrows have moved to focus their fixed income exposure on more niche areas of the market that can better weather rate rises and inflation.
These two issues erode bond returns, but this can be mitigated by investing in things such as floating-rate notes, which adjust their payouts as inflation rises.
Some government bonds are now offering negative real yields, once inflation has been considered, thanks in part to yields being pushed ever lower on the back of stimulus programmes by the world’s central banks.
The managers now think many fixed income assets are significantly overpriced, yet data from the IMA shows retail investors put almost £600m into bond funds in the second quarter, in spite of institutional investors tempering their exposure.
Mr Borrows said: “Markets are already very twitchy – they are anticipating interest rate rises in the UK, as well as withdrawal of stimulus elsewhere, and that’s going to have a significant impact on bonds.
“We believe investors need to position themselves for what could be one of the most fundamental changes of direction in the markets for many years.”
Mr Borrows said he and Mr Callow were making a “determined and systemic move from bonds into real assets”.
“The paucity of returns in the fixed-income space makes that essential, and we’re concerned about what will happen with valuations as the monetary authorities shift back to a focus on the threat of inflation,” he said.
