AA-rated Bowie warns rising inflation could devastate bond returns

Ignis Corporate Bond  and Ignis Absolute Return Credit manager Chris Bowie thinks creeping inflation will eventually trigger a rise in gilt yields which could inflict serious capital losses on corporate bond fund managers.

Citywire AA-rated Bowie, who was ranked 14th in the Citywire Top 1000 manager analysis, and co-manager Adam Walker, have been defensively positioned for some time as they wait for this scenario to play out, shunning financials, cutting duration and preferring asset backed securities such as the fixed income bonds held by supermarkets. The corporate bond fund has just 10% in gilts and around 7% in cash.

While the pair think that over the short term corporate bonds still offer attractive returns, that scenario could change very quickly and the fund has around 18% in asset backed securities, almost twice the level of the benchmark index.

Inflation will trigger gilt yield rises

The duo, who are in the process of making the corporate bond fund available to European investors, believe the adjustment, when it comes, will be painful for credit investors and that it is likely to occur within months, not years.

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.'

Bowie said that the launch of the Ignis Absolute Return Credit fund last July had been partly to deal with an eventual rise in gilt yields and subsequent capital erosion.

The new fund targets cash plus 5% and uses pair trades, tending to be short on cyclical and long on less cyclical names. The £75 million fund has sterling, US dollar, Swiss franc and euro share classes.

Bowie told Citywire Wealth Manager: '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.'

'As long as persistent deflation does not occur, real yields will adjust upwards. It will certainly not be years away.'