The managers of the Artemis Monthly Distribution fund have cut gilt duration and reduced bond proxy exposure as they warn UK inflation could “easily” reach 5 per cent in the next 12 months.
James Foster and Jacob de Tusch-Lec, who run the £266m income and growth vehicle, have been bracing themselves for a spike in UK prices, which could go “much higher” due to an enfeebled currency and rising oil prices.
“I could easily see 5 per cent in a year’s time,” Mr Foster said. “We are dependent on oil prices and all of those issues, and we have seen sterling depreciate. We are a big importing nation, as well as a big exporting nation.”
August’s consumer prices index (CPI) came in at 0.6 per cent. September’s update is due this week.
Economists have predicted the drop in sterling since June’s EU referendum result will “gradually feed through” into consumer prices, though many have predicted a rise to only 3 per cent by the end of 2017.
While the managers added to 10-year gilts in the run-up to the Bank of England’s August interest rate cut, they have since taken profits and shifted into two-year gilts.
“We have got a bit of risk in our equities and took out risk from duration positioning. We moved shorter from 10 years to two [in gilts],” Mr Foster said.
“Two-year gilts are just a low-risk asset. We will move into something more high-yielding when we see an opportunity.”
The managers also cut exposure to bond proxies – stocks that pay secure dividends and behave somewhat like fixed income vehicles and take the form of real estate investment trusts in the Artemis fund.
“Bond yields would increase [in an inflationary environment]. Bond proxies would then fall in price,” Mr Foster explained.
While cutting back on income securities due to concerns over inflation, the team has been beefing up weightings in other areas hoping to secure income and growth from some mildly unloved sectors.
“We added to some oil stocks and bought a position in [oil firm] DEA,” Mr Foster said.
“We have got plenty of BHP Billiton and [oil company] Total. We bought quite aggressively in February and March when everybody was despondent about commodities and oil prices.”
The managers favour insurance firms in the fixed income space. “We have picked up a couple of specialist insurance companies, including pensions insurer Rothesay Life, which pays a 7.5 per cent yield,” Mr Foster said.
“We like insurance because it’s very specialist and people don’t understand it. The regulator gives us some comfort that [the firms] won’t end up being completely stupid, because they have regulatory control.”
The same rationale lies behind the managers’ preference for bank debt, including legacy Tier 1 bonds, from names such as Lloyds and HSBC.
Mr Foster said: “One of the great advantages of rising [bond yields] is a steep yield curve, meaning banks start to make more money. People generally shy away from bank bonds because they are terrified and don’t understand them. But we think there’s a rich seam of yield from those bonds.”
