LGIM's Hodges braces for painful markets in 2012

Legal & General Investment Management's top performing bond manager Richard Hodges is preparing his £1.8bn Dynamic Bond trust for more pain and heighted volatility to come next year.

Hodges anticipates there will be further risk-off trades early next year as credit rating agencies step in to downgrade a number of the eurozone nations.

In order to protect the fund in difficult markets, Hodges has been adding to his positions in long dated UK gilts and cutting down his high yield exposure.

He has scaled back the fund's weighting to high yield over the last six months, taking it to 28%, down from 45% at the start of the year.

“In the first quarter of next year I think there is the potential for another risk-off trade, and even though high yield on a long-term view has sound fundamentals, the value of the asset class will just end up halving and then halving again like it did in 2008 and 2009 during the risk-off environment,” said Hodges.

He has been buying into the longer end of the gilt market in order to benefit from the prospect of the Bank of England introducing more quantitative easing next year.

“I would not be surprised if the BoE pumps another £125m of monetary stimulus into the economy in order to boost growth, and if this is implemented it will benefit the longer end of the gilt market but will not favour short dated gilts as it will just be a cash proxy,” said Hodges.

The manager said downgrades are on the cards for all 17 members of the eurozone in the next three months, while consensus GDP forecasts are too high.

“I think there will be downgrades early next year and growth will disappoint as potentially there is going to be a French banking crisis.

“There will be further disappointment from peripheral and emerging eastern European economies and even the consensus forecast for German GDP at 1% is far too optimistic.”

Hodges admitted the performance of the Dynamic Bond trust over the past year has been disappointing. The fund has slipped into the bottom quartile of the IMA £ Strategic Bond sector, falling 4.8% over the year to 2 December compared to an average return of 1.7%.

Over three years the fund is top quartile with a return of 51.7% against a sector average 36.9%, according to Morningstar.

Hodges said the fund had been positioned for an optimistic outlook for the US economy at the start of the year, which contributed to its less than stellar numbers.

“The returns have been disappointing in shockingly illiquid markets. We were too optimistic about the US economy and this has ultimately affected performance,” he said.