View the article online at http://citywire.co.uk/money/article/a653124
Bowie: inflation could trigger 30% losses for bond funds
Top rated bond fund manager Chris Bowie has warned creeping inflation could inflict serious losses for some bond investors.
Top rated bond fund manager Chris Bowie has warned creeping inflation will eventually trigger a rise in gilt (UK government bond) yields which could inflict serious capital losses for some corporate bond funds.
Citywire AA-rated Bowie has defensively positioned both the Ignis Corporate Bond fund he has run for four years and the Ignis Absolute Return Credit fund which he launched last year to deal with the threat of rising inflation, higher interest rates and a consequent fall in bond prices caused by yields rising in line with the cost of borrowing.
Bowie has avoided most bonds from financial companies, cut exposure to the risk of rising interest rates and bought asset-backed bonds issued by supermarkets. The corporate bond fund has just 10% in gilts and around 7% in cash.
While Bowie thinks corporate bonds still offer attractive returns in the short term, he warned the situation could change very quickly.
'For now, wage inflation is not an issue in the UK and consumer prices have fallen from recent highs but I think real yields on gilts will adjust back up towards 2.5% within the next few months,' Bowie said.
'As long as persistent deflation does not occur, real yields will adjust upwards. It will certainly not be years away,' he added.
Bowie said: 'When it comes, fixed income returns will be hit hard. As a general rule, credit loses 7.8% of its capital for every 1% move higher in gilt yields. Ten-year real yields on gilts are about -1% and the long-term average is 3%.'
'If it goes back to the long-term average that is a capital loss of 30% so we think all the risks are on the downside.'
'We have minimum exposure to financials and consumer-related bonds and prefer supermarket bonds which can provide the reassurance that if they did default, the bond holders would have the right to their assets, be it machinery, property or land,' he said.
Bowie's comments come amid signs that investors are moving money from expensive bonds into better value shares. Citywire Money columnist David Kempton has also said he has sold all his government bonds.
Three of the corporate bond fund's top 10 positions are in bonds issued by Sainsbury and Tesco, which invest in the property portfolios of the supermarket chains.
The fund also has around 10% in floating rate bonds where the coupon is reset every three months. These should do much better as interest rates rise.
'In one of the next five years we expect double digit losses for credit so we can use these floaters to protect against that.'
Over three years to the end of December, the fund has returned 37.6% compared to the Markit iBoxx Sterling Corporates index which it uses as a benchmark. It returned 32.4%
The new Ignis Absolute Return Credit fund targets a return of cash plus 5% and like the corporate bond fund is co-managed by Adam Walker.
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by Gavin Lumsden on Oct 28, 2016 at 16:26