Henderson Strategic Bond fund

With returns across the bond universe growing increasingly disparate, many investors have turned to so-called strategic fixed income funds to navigate these markets.

We have become more agnostic on gilts and traded them at current valuations, although yields are clearly absurd

John Pattullo

Henderson’s John Pattullo is a strong advocate of asset allocation within fixed interest portfolios, citing varying risk/return profiles on different levels of debt. “High yield can easily be up 40% one year and then down 20%, as can gilts,” he adds. “A more flexible mandate allows us to shift into the most appropriate assets depending on the point in the cycle, taking account of interest rate and default sensitivity.”On his own £1.02bn Strategic Bond fund – run in partnership with Jenna Barnard – Pattullo uses credit derivatives and interest rate futures to manager duration and default risk, without having to disturb underlying assets too much. “We effectively run the fund with two portfolios as well as 10-15% in cash,” he says. “Most of the assets are in physical bonds, which are invariably held for longer as they are less liquid, which is effectively our stockpicking book. We also use derivatives and futures to manage beta and duration risk, which can be extremely beneficial for performance at times of market stress such as 2008.” In the simplest terms, Strategic Bond is looking to achieve positive performance by investing in fixed income and is very much a total return product rather than purely yield focused.Although it makes quarterly distributions, Pattullo says this is not an income fund and is most suitable for investors seeking return and risk diversification away from equities. “In our range we also have Preference & Bond, which is more focused on its quarterly distribution, and Fixed Interest Monthly Income, and these will be more suitable for older investors needing yield,” he adds.

Riding out the blips

Among the earliest strategic bond launches back in November 2003, the fund retains a solid long-term track record despite what Pattullo describes as a disappointing blip in 2011.More recently, the managers have largely made good their losses from that difficult period, adding 3% to returns in the last few months. “2011 was undeniably a poor year for the fund, largely because we were not positioned to benefit from the huge government bond rally and had too much in financials,” says Pattullo. “While we saw little value in government debt at such low yields, we reversed a short gilt position in April and also bought German bonds but did not have enough exposure relative to the sector as investors continued flocking to these so called safe havens.We were taken by surprise by the risk aversion effect of a US slowdown and deflationary scare in the eurozone and simply did not own enough gilts or gilt-sensitive assets such as investment-grade industrial bonds.” Credit also sold off in this environment of heightened risk aversion so the portfolio took a hit on its positions in investment grade and high yield.Explaining the much-improved returns this year, Pattullo says much of the core bond book remains in place although he has continued trimming financials to around 20% and added various investment grade industrials as well as gilt futures.Elsewhere, the managers have also implemented various material hedges that have all come good, currently around 30% short credit derivatives across various UK and European financial names as well as the subordinated financials index.Pattullo also notes a 10% short position in the Australian dollar, a long in the US dollar and a short in the euro as performance-adding positions. “More generally, we have also become more agnostic on gilts and traded them at current valuations, although yields are clearly absurd,” he adds. “Money continues to flow in as investors see the UK as a safe haven and it is hard to say when yields get too absurd – it may be 1.5% but it could just as easily be 1%. In the meantime, we have traded this market using gilt futures.”While disappointed with last year’s performance, Pattullo also points out the oddities of his fund’s Sterling Strategic Bond peer group. Alongside his direct competitors, this sector also includes several long-dated gilt and corporate bond funds, which floated to the top as government bonds rallied and have subsequently dropped off.