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Should shrewd bond managers prepare for a shock

The volatile mix of global divergence in monetary policy and some highly charged geopolitical hotspots should give fixed income fund managers plenty to think about over the coming weeks.

With the US and UK economies heating up interest rate rises have become inevitable and the questions are when and by how much, not if.

In continental Europe and China however, economic performance is far from stellar and in the case of the former, unprecedented monetary measures are on the cards in the form of quantative easing carried out from a single central bank across multiple independent sovereign debt issuers.

Given all this what should fixed income investors do? According to Rathbones fixed income manager Bryn Jones taking duration down a notch is the order of the day.

“The divergence between the US and UK on one hand and mainland Europe and China on the other reminds me of the old Levis advert with two horses pulling a pair of jeans in opposite directions,” he said. “In that case the jeans do not split however it’s a fallacy and the jeans will rip apart in reality,” he added.

“This is a potentially very dangerous for fixed income markets so we are reducing duration in our portfolios,” Jones continued. “We are cutting back on long-dated Gilts and putting them into T-bills and floating rate notes,” he added.

Jones said that he considers the Gilt market very overpriced relative to the risk around at the moment with T- bills a better option. He is also reducing exposure to non-UK banks and placing a greater emphasis on in-house credit research to help him tackle the markets. “You need to be sure that you only buy assets which you can hold a long time if you have to due to the lack of liquidity in markets,” Jones noted.

He is not the only one who sees FRN’s as a good way for investors to add protection to portfolios. Last week M&G Investments announced the launch of a new fund specifically targeting a high exposure to FRN’s as a hedge against rising interest rates in the US and UK.

J.P. Morgan Asset Management’s global market strategist Kerry Craig describes the present conditions in world fixed income markets as ‘fear and loathing.’ In reference to the Hunter S Thomson novel.

“In the book, nothing is as it seems, which has odd parallels with how the bond market has performed this year, going against many investors’ expectations,” Craig said. “[There is] fear over what might happen to the bond market if yields on government bonds continue to decline in the face of stronger economies in both the UK and US, and investors loathing that they may have missed out on this seemingly unexpected rally,” he added.



Part of the Mark Allen Group.