Thesis' Lally pushes duration out nine years on short squeeze fears

‘[At current values] the only way you can make money on short duration is derivative structures. At some point you are going to get a whole rush of distressed buyers flooding into [long] duration.

‘And long-dated issuance by corporates is only just getting started. If chief financial officers can lock in these funding costs over 20 years, why wouldn’t they? It’s like Christmas has come early.’    

With the short to medium-term outlook dominated by policy risk, he adds that in the absence of inflation, it is hard to see where downward pressure on bond pricing is going to come from.

Balancing costs

This could partly explain recent underperformance on many fixed income hedge strategies, with managers caught in a short squeeze as risk aversion moved against them.

‘I think a lot of people went long equity risk and short gilts, which has been a very volatile trade,’ says Lally.

While pushing out duration over the course of the year, the company has steadily sold out of almost all its gilt holdings across almost all of its risk-rated portfolios.

Instead, it has taken global sovereign exposure, using the Pimco Global Absolute Return fund to balance costs and liquidity with a healthy amount of exposure to emerging market debt.

While sceptical about the more apocalyptic end of inflationary expectations, the company has also diversified into global inflation-linked securities via funds such as Thames River Global Bond , although he says that over the shorter term, managers Paul Thursby and Peter Geikie-Cobb mistimed several calls and are currently ranked 58 out of 60 in Citywire’s Bonds – Global sector.

‘We recognise that different countries have different drivers of inflation. We are not expecting any form of inflationary shock but with rates near zero, even 2% to 3% inflation offers a decent return,’ he says.