Baring Multi-Asset fund manager Andrew Cole heads for linkers against the threat of the end to quantitative easing, has been reducing his duration risk and is limiting high yield.
When US Federal Reserve chairman Ben Bernanke twitches, markets move. And Bernanke has twitched, pushing Andrew Cole, manager of the £420 million Baring Multi-Asset fund, into inflation-linked treasuries.
When Bernanke talked in May about the eventual tapering off of the monthly injection of $85 billion (£57 billion) of quantitative easing (QE), dependent on economic conditions improving, markets went into a panic.
Bond market ‘overreaction’
Cole said he had been surprised by Bernanke’s statement, but he felt the bond market had overreacted in the short term.
‘It’s right and proper we contemplate a world with less QE, and, to some extent, Bernanke has been ensuring in part his own legacy as his term is coming to an end,’ Cole said.
‘He has orchestrated the grand experiment, which is set to unwind, but it might not do so once the next guy takes over.’
Cole said there were still headwinds for the US economy, including weak capital investment and the looming full impact of budget cuts.
He has 6% of his fund in US inflation-linked treasuries, mostly long-dated, having recently sold a US nominal bond set to mature in 2015.
According to Cole, US treasury yields were showing real value compared with UK gilts, and had risen nearly 100 basis points (bps).
He said the implied yield for 20-year inflation-linked bonds in 10 years’ time was in excess of 1.8%, and this suggested there was value at the long end of the inflation-linked yield curve.
‘If we were to offer any UK investor a guaranteed 2% return, they would bite your arm off,’ he said.
Reducing duration risk
Cole has reduced his duration risk. In 2012 it was around three to four years, and now it is two years.
‘If we saw bond yields decline by 20bps to 30bps, we would start reducing our duration once again,’ he said. ‘We think the Fed has been overly hawkish. Draghi and Bernanke both said that if bond yields kept rising like that, it would derail the notion of an economic recovery.’
The fund also has 13% to 14% exposure to US high-yield corporate bonds.
‘It’s been a less pleasant experience over the past month, but we had relatively short duration, so we suffered less than the index,’ Cole said. ‘It’s in dollars, which has gone up against the pound. It helped in that sense in the overall portfolio.’
High-yielding dollar assets have proved less risky than sterling assets, which displayed more weakness with every hiccup in the market, according to Cole.
‘Much of our high-yield exposure is short-dated and much of it is loans where interest rates are reset every three to six months, so we’re trying to keep overall interest-rate risk to a minimum,’ he said.
The shape of the fund has changed a lot over the past year. This has included slashing exposure to Australian government bonds from 20% to about 3.5%.
Danger of recession
The fund’s future exposure to high-yield bonds may be limited. Cole said his preference was to back out of this asset class.
Within equities, he prefers UK, US and Japanese markets, and is increasingly focusing on US domestic stocks instead of global multinationals.
‘We had a pretty strong bull market in equities of late and we participated in that,’ he said. ‘Do we think the best opportunity of a generation has passed us? Probably not, and the past month has been a lesson.’
Cole said a prolonged rise in government bond yields would present a headwind for equity valuations and investors would get the opportunity to buy into depressed earnings with single-digit price-earnings ratios.
‘We might need another recession to get us there,’ he said. ‘We are not out of the woods at the moment. The US economy has required huge amounts of stimulus to get us to that level. If they are genuinely thinking about reducing that stimulus, presumably we would not need to take much of a shock to get back into a recession.’
He said he did not know what that shock might be, but gave an example of the Fed hiking interest rates ‘too early’.
‘And if you headed into another recession, it’s difficult to imagine what policy leaders would be left with to restimulate growth,’ he said.
Since its launch in March 2009, the Baring Multi-Asset fund has returned 45.3%, behind the LCI UK Equity & International Balanced (60:25:15) benchmark’s 73% over the same period. But the fund has beaten its target of inflation (RPI) plus 4%, and is about level with the Citywire Mixed Assets – Absolute Return sector average.
But Cole remains optimistic. ‘We haven’t panicked,’ he said. ‘We had a strong start to the year. We know where we are going.’