Henderson Strategic Bond fund manager John Pattullo has moved aggressively in to gilts in a bid to hedge against a worldwide deflationary shock caused by the chaos in emerging markets.
The manager (pictured) of the £1.1bn bond fund said he is increasingly concerned about deflation as a result of the emerging markets slowdown, and has bought back into UK government bonds in case there is further fall-out from the EM crisis.
He said a slowdown in emerging market economies could release a “deflationary pulse” which spreads to developed markets.
“We are worried about a potential deflationary shock to world growth. In that environment, you have got more duration, which is why we have added to the asset class,” Pattullo said.
Pattullo and co-manager Jenna Barnard have been buying gilt interest rate futures since mid-January - taking their total exposure in the fund to 20% - a move which reverses a call in September which saw them exit gilts.
Buying futures allowed the managers to avoid selling high-yield bonds, he said: “We wanted some interest rate exposure. We could have bought investment grade bonds, or we could have bought gilts, but it is just cheaper to buy gilt futures.”
The move means the fund’s duration has climbed sharply to 5.2 years, up from 3.6 years in December, and coincides with a move higher for gilts and treasuries in the last few weeks. Yields have come back down to multi-month lows as investors react to the EM crisis by buying safe haven bonds.
The EM crisis intensified last month – spooking investors – after shock rate hikes by central banks in Turkey and South Africa sent bond yields racing higher. Fears remain that US monetary tightening will hit indebted emerging market countries, with yields on EM debt still elevated.
Pattullo said it was too soon to buy emerging market bonds, as he does not believe they are cheap enough. He also expects more emerging market countries to raise interest rates.
However, he forecast a longer period of low interest rates in the UK than the late 2014 rise currently priced in by the market. “Mark Carney is talking it down now. But given we are quite worried about global growth, we think the Bank of England may keep interest rates at their current level until after the election in 2015,” he said.
Referring to the news some bond fund managers fear credit risks in the high yield sector are building, Pattullo said his high yield holdings have probably peaked: “We will take a decision at some stage about taking profit on those. We are not complacent on the credit cycle.”
In the three years to 4 February 2014, the Henderson Strategic Bond fund has returned 18.6%, compared to a sector average of 20.8%, according to FE.
