Fixed IncomeMay 26 2017

RLAM’s Inches boosts long-dated exposure

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RLAM’s Inches boosts long-dated exposure
Craig Inches says prices of longer-dated gilts could rise by the summer

Fixed income manager Craig Inches has been stocking up on ultra long-dated gilts as part of a “yield curve play” designed to exploit anticipated demand.

Mr Inches, who runs Royal London Asset Management’s £571m UK Government Bond fund with Paul Rayner, said that while 10-year gilts had outperformed other parts of the curve recently, he expected this trend to reverse.

“For us it’s about the yield curve. One of the key moves has been a large outperformance of the 10-year sector,” he said. 

“Longer-dated and shorter-dated [gilts] have struggled slightly. Our view is between now and the end of the year, yields will track up towards 2 per cent on the 10-year.”

As such the manager has reduced his 10-year gilt exposure, while adding five-, 40- and 50-year UK government debt to the fund.

Mr Inches believes supply and demand dynamics could push up prices of longer-dated bonds as early as this summer. “Once we get this syndication out of the way, there’s not likely to be much ultra long-dated supply until December. There could be a shortage,” he explained.

“In summer, when volumes get lower and pension funds need them, they get in demand and tend to outperform. That seasonal flow has pushed us to be overweight long.”

He noted that other technical factors – including an increase in duration for a bond index – could act as a tailwind for longer-dated instruments.

“The 2032 [gilt] will move out of the 15-year index,” he said. 

“That extends duration on the index by 0.6 years. That’s another catalyst for it to do well, as people will see their benchmarks get longer [and they follow the index].

“We have probably got a medium conviction that longer-dated assets will perform well versus the 10-year assets.”

Despite the shift towards the long-dated securities, Mr Inches, remains cautious on duration relative to his FTSE All-Stocks Gilt benchmark.

The fund had 14.6 per cent allocated to medium-dated bonds at the end of April, marking an underweight compared with its benchmark’s 15.4 per cent. This is in addition to the 36.8 per cent in short-dated gilts, versus 32.2 per cent for its index, and 48.5 per cent in long-dated instruments compared with 52.4 per cent for the benchmark. 

Its overall duration at the end of April was 10.7 years, compared with 11.1 years in the index.

Mr Inches’ strategy comes as part of a broader market caution towards gilts, which the manager views as both volatile and richly valued. “Yields have moved 10 to 12 basis points (bps) lower than at the start of the year, but the range has been about 50 bps. There’s been quite a lot of volatility,” he said.

“We think bond yields look too low. Based on the economic data, if we were to ignore Brexit we would probably more resemble the US. But because of Brexit the Bank of England can’t put rates up, so gilts have generally outperformed the wider market.”

The UK Government Bond fund has returned 19.2 per cent over three years, compared with the 23.6 per cent average from its IA UK Gilts peer group, data from FE Analytics shows.