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RLAM ditches gilts in favour of Japanese bonds

RLAM ditches gilts in favour of Japanese bonds

Japanese bonds have come back into favour with the fixed income team at Royal London Asset Management, who have dumped UK gilts to buy the Asian debt.

According to fund managers Paola Binns and Craig Inches, the management team have been carrying out the Japanese government bond versus UK gilt trade because of inflationary fears in the UK.

Although 10-year Japanese bonds have a 0 per cent coupon, this is likely to hold at this level due to government policy.

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However, concerns over the direction of the UK base rate - currently at 0.25 per cent, fears of rising UK inflation and a concern over the immediate effect of triggering Article 50, means the managers are not confident in UK gilts being able to keep pace with - or outpace - rising inflation.

This is all the more pertinent as consensus estimates for UK inflation growth suggests it could rise to 2.8 per cent over the next 12 months.

Ms Binns, who runs the £185.83m Royal London Short Duration Credit Fund, which was launched in October 2013, said the team were keeping a close eye on developments in the UK, particularly if the Bank of England has to cut rates further, or the triggering of Article 50 has an effect on bond yields.

Mr Inches added: "It is about finding the cross-global opportunities in corporate bonds for diversification.

"Japan is currently targeting a 0 per cent yield on its 10-year bond. If we think the UK is still expensive, then we will continue to switch into Japanese bonds."

The idea behind the trade is to sell some gilts and buy the Japanese bonds, with the expectation that gilt yields will eventually rise. This means the managers will sell the Japanese bonds and buy gilts back when they look better value.

What the managers said they were hoping to achieve was not to chase yield but to protect against any movements in spreads which could cause the UK to seriously underperform in the short-term. "It's all about the valuations", Ms Binns added.

To avoid this scenario having a negative effect on the portfolios, the managers advocated maintaining a shorter duration and getting inflation hedging from holdings such as the Japanese 10-year bond.

Mr Inches, who runs the £296.18m Royal London Short Duration Gilt Fund, explained: "We are keeping duration short, being selective and adopting a wait-and-see policy. 

"We are always asking 'are we being compensation for the risk we are taking?' Ultimately, the longer duration you go at the moment, there is no compensation for this level of risk."

This Japanese/UK gilt trade has been carried out in the £532m Royal London UK Government Bond fund, along with some of the asset manager's longer duration and all maturity segregated bond mandates.

simoney.kyriakou@ft.com