GAM credit opportunities manager fears for mainstream bonds

‘I call it the virtuous circle. You want the momentum. There are always going to be reports of scandals and fines but you want the banks to be moving, cleansing from the crisis. It is a cleansing process and this is happening, which has been good for the shares in the recent while, but we are dealing with the credit, and the credit is becoming safer.’

Debt issued by Direct Line, Scottish Amicable and Rothschild currently feature in the fund’s financials exposure, alongside global franchises including HSBC and AXA.

Locking in yields

While the market looks ahead and prepares for an eventual pick-up in interest rates, Smouha believes the best way to prepare for this – alongside the bond market’s potential pre-emptive reaction – is to lock in higher yields now. Likewise, floating rate notes have helped to drive returns in the fund, and the bond specialist anticipates they can continue to buoy performance.

‘They say they are going to keep interest rates low. In our experience, bonds start anticipating a pick-up in short-term interest rates a good 12 months ahead and we want to be prepared for that by having a proportion in high current coupon, and a portion in the fixed and floaters so that our duration is half the benchmark, so you have a higher yield to maturity and a lower duration,’ Jeremy adds.

Alternative to index-linkers

Floating rate notes can offer a viable alternative to index-linkers, which are offering a negative real return at the moment, according to the duo.

‘I prefer to buy a Barclays floating rate note perpetuals at 100 over libor in the mid-50% range than to buy index-linked,’ Anthony says.

His brother adds: ‘We are happy with the discounted floating because they offer the opportunity of a capital gain when interest rates go up.’

Over the past 12 months, the Star Credit Opportunities fund has posted a 26.5% return and has a yield of 7.2%, while the Citigroup UK WGBI index rose 2.7% over the same period, according to Lipper. Looking ahead, although Smouha anticipates it will be tricky to replicate the solid returns of 2012, he expects some individual holdings have ‘further to run’, particularly if markets improve.

‘We will try to take advantage of different moves [in the market], so some capital gain. A lot in the coupon. We do not expect another 2012; that kind of return would be almost worrying if it happened again,’ he says.