Fixed income managers prepare for sharp increases in UK interest rates over longer term, with move towards high-yield and floating-rate instruments
Fixed income managers have shifted towards high-yield and floating-rate instruments on concerns of hikes in UK interest rates this year.
They stand ready for sharp increases over the longer term, but doubt a prediction from Barclays Capital last week that UK rates could hit 6.5% in 2015.
The average prediction from 16 managers polled by Investment Week suggests UK base rates will be 1.3% in December, and inflation 1.7% – benign compared to 0.5% and 2.9% now.
Howard Cunningham, manager of Newton Investment Management’s International Bond fund, warns of a danger of rates rising dramatically if no credible plan emerges to tackle Britain’s deficit, or if UK debt is downgraded.
He says: “I do not rule out 10-year rates at 6% if Britain sticks its head in the sand and loses the confidence of the markets.
“This is not an impossible scenario, but we would see it as less likely than a slow-grind, low inflation, sub-par growth scenario, with possible pockets of inflation in geographies or asset classes. The further out you go, the more difficult it gets to forecast.”
John McNeil, fixed income manager at Aegon Asset Management, says: “At present, it feels like a very low inflation, low interest-rate world.
“It is a relatively benign market for fixed income; wage pressure remains very low and the Bank of England says, at the two-year horizon, inflation will be below their 2% target.
“When we started easing, the bank rate was 5.75%. I do not think we are going back to that level. Rates could peak at 4%.”
Expecting mild rate rises, however, managers are tending towards high yield debt.
Fatima Luis, F&C’s head of UK high-yield credit and manager of its Strategic Bond fund, says: “Rates going up will impact on the high-quality securities, in which case you go down the rate curve.
“That is what we have been doing since the beginning of last year, reducing investment grade corporates. We have also increased securitisations.”
She adds the securitisation instruments her fund bought are not on residential property, but on large retail such as supermarkets.
Richard Marwood, manager of Axa’s Ethical Distribution fund, has 35% of assets in index-linked gilts, and he has run conventional gilts down from 7% to just 2%.
“I do not see much value in traditional gilts. Inflation is something investors have to protect themselves against,” he says.
Bryn Jones, manager of Rathbones’ Ethical Bond fund, says buying floating-rate instruments, whose rates reset quarterly, is another useful strategy for inflationary conditions.
“If rates start rising, I would move to be a bit more defensive. You shorten your duration. We currently have duration of 5.25 years, based on extra supply coming to the market.”
If Barclays’ 6.5% prediction is correct, Luis says: “It is about being as nimble as possible.”
