Eric Holt has taken advantage of demand from a slew of recently launched short-duration bond funds by offloading his unwanted instruments in the space.
The second half of 2016 was marked by several asset managers launching short-duration strategies in order to offer investors bond funds that could mitigate the impact of rising rates.
As manager of the £1.4bn Royal London Sterling Extra Yield Bond fund, Mr Holt took advantage of this demand by selling short-dated instruments and recycling this capital into higher yielding, longer duration assets.
The manager said he was selling lower yielding six- to 12-month paper to buyers in the market on the back of strong demand levels after several fund groups, including his own company, launched funds targeting a duration of between one and three years.
“It’s fine, and it makes a market,” Mr Holt said. “I’m not saying they are inherently expensive. A bond that yields 1.5 per cent for 12 months – that’s actually attractive against gilt yields, but we can choose to recycle that money into more attractive returns over the medium term.
“It’s not everything that’s short dated but I have certainly taken advantage of opportunities to sell at what looks like attractive levels, just to move the investment of the fund a little bit longer.”
Despite having sold short-duration paper to these strategies, Mr Holt has kept duration in his own fund low at five years.
However the manager said his portfolio’s sensitivity to interest rate moves was even lower than this figure implied.
He used the example of a CCC-rated Annington Finance bond set to mature in 2018. Mr Holt said the holding, which yields around 5-6 per cent, represented value despite its short duration, justifying its top-10 position in the fund.
The rating, which implied a 40 per cent chance of default in a 10-year period, had forced up the yield, according to Mr Holt. He said the fundamentals of Annington Finance, which buys Ministry of Defence married quarters, were safer than its rating suggested given its £6bn asset base.
Mr Holt highlighted picks like this to argue the fund remained committed to focusing on income and security, rather than upside potential.
This assertion came despite a strong 2016 for returns, which saw the strategy becoming one of the top performers in the IA Sterling Strategic Bond sector over the 12 months after a difficult start.
It lost almost 3 per cent in the opening two months of last year, but came back strongly in the second half – despite yields rising on some government and corporate debt.
The manager said bond markets earlier in 2016 were supportive but not the main contributor to performance.
“Strong income generation was a major part of [our] return,” he said. “We had an opportunity in the earlier part of the year to invest in long-dated assets that performed well.
“Investment-grade bonds delivered the same type of performance volatility as equities [in the opening months], and that was supportive to buying at attractive at levels,” Mr Holt added.