Mark Dampier: Bond fund can make money despite fashion for equities

The Analyst

There has been talk of a "great rotation" among investment commentators and the press. Recent rises in equity markets have been attributed to investors selling bonds to buy shares. Many have speculated that this rotation into equities from bonds hails the end of the bond bull market.

There is no factual basis for this. The latest IMA figures showed £85m flowing out of bond funds; tiny compared with the billions which flowed in over recent years.

It would be naïve to suggest bonds can perform well indefinitely. Yet there are many different types of bond. Talk of the great rotation has centred on sovereign (or government) debt, particularly bonds issued by the US, UK and German governments. These performed well while concerns over the global economy and debt in the eurozone's periphery rumbled on. They do look expensive relative to history, but one could argue that conditions in the West justify current valuations. We remain in a recessionary period and interest rates show no sign of rising. In addition, the Funding for Lending scheme has pushed rates on cash deposits down further at a time when investors remain hungry for income.

It might be fair to say we are nearer the end of the bond bull market than the beginning, but I don't think bonds can be written off yet. I still believe that some funds, such as Old Mutual Global Strategic Bond, managed by Stewart Cowley, have the potential to make money for investors.

Mr Cowley believes the UK is backed into a corner. The Chancellor is unable to spend more to stimulate the economy without a volte-face, nor is he able to implement further austerity without risking an embarrassing return to recession. His only possible salvation is the "quiet devaluation" of the pound so that UK exports become increasingly competitive globally and provide much-needed growth.

In this George Osborne could succeed, but it means the omens for the pound are not good. Sir Mervyn King, the Governor of the Bank of England, voted for more quantitative easing at the most recent meeting of the Bank's Monetary Policy Committee. He was outvoted, but the new Governor from July, Mark Carney, might be more aggressive in supporting it, and has hinted at more unconventional methods to target economic growth. In the currency devaluation race sterling could easily take the lead.

In a world where most major currencies lack appeal, Stewart Cowley is presently adopting an "anything but the pound" strategy. The fund's exposure is therefore across a basket of currencies, which sets it apart from many other bond funds. Euros, US dollars, Chinese renminbi and smaller currencies such as the Swedish krona and Polish zloty are held. This has already benefited the fund given the pound's recent falls.

Currency devaluation might be welcomed by exporters and politicians, but it could increase inflationary pressures as the cost of imported goods rises dramatically. Mr Cowley has 50 per cent of the fund in inflation-linked bonds issued by the US and UK governments. As the name says these are designed to provide a return linked to the rate of inflation and they could benefit if inflation takes off.

Mr Cowley has also been targeting certain government bonds he expects to weaken. This fund gives him the flexibility to profit from falling as well as rising asset prices, and he has been shorting conventional Japanese and French government bonds. He also implemented an opportunistic short position in Italian government bonds in January. In light of the recent inconclusive election in Italy it proved to be a shrewd and profitable move.

As you will have gathered, this is not a conventional bond fund. Mr Cowley uses a variety of strategies, including higher risk derivatives, with the aim of maximising total returns. He has no specific goal of generating income, and with a yield of around 2 per cent it is unlikely to appeal to income seekers. Indeed, this yield is highly variable depending where the fund is invested, which given the broad remit could be anywhere in global fixed interest markets, including higher-risk high yield bonds.

This fund could appeal to investors partly as an insurance policy against a future bond bear market. In the shorter term it could do well if the pound continues to decline; conventional government bonds continue to sell off; or if concerns over inflation rise further. In contrast, this fund will not appeal to investors who do not believe any of the above scenarios are likely. I trust Mr Cowley to position the fund to benefit from prevailing economic conditions, and I recently sold my last conventional investment grade corporate bond fund to take a position in this fund.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit hl.co.uk/independent