Going short duration has been the dominant call among investment managers in the face of impending interest rate rises.
Although many have been caught out by the surprising strength of bond markets this year, investors say the trade still stands as Bank of England governor Mark Carney forecasts rates to stabilise at around 2.5% in three years’ time. With this in mind, just how low duration are investment managers going right now?
Charles Hepworth, head of GAM’s managed portfolio service (MPS) and a former Wealth Manager cover star, says the duration on a medium risk model is around two years, compared with four to five years at the beginning of the year. The figure has been pulled down by the model’s position in the Ignis Absolute Return Government Bond fund, which is currently negative duration.
This is a call Hepworth supports due to the likelihood of rate rises, which could happen between November and May 2015. He said there could even be two rises, with just a half a percentage rate increase resulting in serious capital drawdowns.
Alongside the Ignis fund, the team also backs GAM Star Credit Opportunities. It has a duration of around six years, but Hepworth said the figure is really lower due to the optionality to move from a fixed to floating rate structure.
The team has exposure to convertibles through the GAM Star Global Convertibles fund. ‘You get an equity kicker when a lot of investors are chasing any yield they can get. For us it has to be as low duration as it can be as we expect rates will go higher, potentially before the election,’ Hepworth said.
As long as rate rises are slow and steady, he does not anticipate too great an impact on markets, outside of conventional gilts. The medium risk model currently has 17-18% in cash and fixed income.
Brooks Macdonald is running a higher duration of around four years in its medium risk model, with a total bond exposure of 16%.
Brooks’ MPS head Jonathan Webster-Smith acknowledges ‘it costs you to hold short duration’ and while the call has not paid off in recent months, he expects it will come good soon.
Quilter Cheviot has a duration of around six years on its medium risk model. CIO Duncan Gwyther said: ‘Short rates are still being held down artificially, at least in our view, but with inflation likely to remain relatively benign we expect the yield curve to flatten. We don’t share some of the more extreme views but estimate returns will be very low.’
A medium risk model has around 32% in bonds, with roughly half in conventional gilts on account of their liquidity and safe haven status, 20% in index-linked gilts and the rest in corporate bonds.How the medium risk models compare
- Quilter Cheviot
Bond exposure: 32%
Duration: Six years
- Brooks Macdonald
Bond exposure: 16%
Duration: Four years
Cash & bonds: 17-8%
Duration: Two years