Old Mutual's Stephen Snowden has avoided issues by taking neutral duration position and focusing on individual stocks over the last three years
The collapse of the long-dated credit market in 2006 was the big story of the UK Corporate Bond sector over the past three years, having a dramatic effect on the returns of almost every fund operating in the space.
Long-dated bond funds dominated the sector in the year to the end of February 2006, according to Morningstar, with the top five funds all focusing on this end of the market.
However, those same five funds dropped back to the bottom quartile in the year ending February 2007, as yields and returns fell dramatically on 15-year plus debt.
One of the few vehicles that managed to outperform in each discrete 12-month period was Stephen Snowden's Old Mutual Corporate Bond fund.
It delivered a bid to bid return of 9.67% in the year to end February 2005 against the peer group average of 6.77%. In the following 12-month period the fund's return was 9.09% against a mean of 7.54%. The vehicle topped the table in the 12 months to February 2007, returning 2.97% against a mean of 0.4%.
Snowden said he outperformed his peers by running an index-neutral strategy, concentrating instead on individual stock selection.
"It is clear from the performance statistics that managers who run long-dated funds topped the peer group in 2005 but in 2006 they fell right down to the bottom of the sector," he added.
"We run a neutral duration position and have been only modestly long or short over the past three years."
He said with hindsight a fund going short duration in 2006 and long duration in 2005 would have produced fantastic returns. But he added that not a single corporate bond manager had called the market right on a macro level.
"What is embarrassing for the industry as a whole is that nobody got it right, at least looking at the evidence in peer group performance," he said. "Long-duration managers in 2005 were not able to take their long exposure off the table in 2006 and got badly hurt."
Snowden said the difficulty in calling the market is core to how he manages money, generating returns by stock selection alone.
"We see this as providing the most consistent way to produce returns in very volatile markets. We try to keep big macro bets to a minimum," he added.
Snowden has focused heavily on asset-backed securities (ABS), which have a common theme of property.
"These have been anything from nursing homes to pubs to student accommodation," he said. "The sector used to trade cheaply but after fund managers became panicked by leveraged buyout risk, ABSs have performed very well."
Snowden also favoured property debentures, which he said were typically unrated, causing managers to ignore them.
"Property prices have since soared and managers have begun to appreciate their true value," he said.
By contrast, New Star Sterling Bond manager Philip Roantree, who favours short-dated bonds, benefited from taking a bearish view on long-duration debt in the final discrete year examined.
Roantree saw his fund move from third quartile in the year to February 2006 to first decile over the final 12 months examined, generating a return of 2.25% in the year to February 2007 against the sector's 0.4%.
By contrast, in the year to February 2006, the fund was up 6.98% against a peer group return of 7.54%.
Roantree said the key influence on the bond market has been the inverted yield curve in the UK.
"This has been driven mainly by life companies and pension fund demand for longer gilts," he said. "Throughout this period, even during the high returns of 2005, I have been averse to long-dated bonds and have held nothing beyond 20 years."
Roantree favoured using floating rate notes, which adjust to reflect the current level of interest rates. They make up 17% of his portfolio.
"I have also tended to own weaker rated investment-grade bonds such as BBB-rated paper," he said. "However, BBB spreads at a 10-year level are not offering great value with so much money chasing extra yield so I have been increasing the quality of the portfolio."
Performance on funds such as Société Générale's Long Dated Corporate Bond fund are typical of portfolios that focus solely on the quality end of the market.
Manager Marie-Suzanne Mazelier said the rules of her portfolio mean she must invest a minimum of 80% in AAA to AA-rated bonds and in paper with more than a 10-year maturity date. Her fund rose 12.17% in the year to February 2006 but fell 2.6% in the 12 months to February 2007.
"This means that when the gilt market is performing, funds with high duration will perform better," she said.
"The lower gilt returns of the past 12 months can explain most of the underperformance."
Turning to annualised alpha, which measures the relative performance of a manager compared to the amount of risk taken, New Star's Roantree topped the table, recording an alpha of 2.9.
At the other end of scale is Nigel Sillos's institutional fund BAM Long Maturity Corporate Bond, with an alpha of -4.68.
Overall, the sector average was 0.25.