2013 has been good to equity investors so far but Tideway Investment Partners thinks there are better opportunities in the fixed income and currency markets.
The company has an absolute return fund that last year made a total return of 24 per cent from the bond markets. James Baxter, managing partner of Tideway, says: "We believe you can invest in fixed income with a more certain outcome than the equity markets. For example, we know that gilts are expensive - if you hold them to maturity you only get 3 per cent.
"A lot of the equity markets rise in the last few months will be depreciated by sterling.
"What we know about the UK is that it is not in good shape. Sterling was benefiting from perceived risk, in being a safe haven from the eurozone. But there is a chance that whole trade unwinds."
Although it is early days for the Tideway UCITs Global Navigator Fund (ISIN: LU0639321321), it intends to stick with its leaning to the fixed-income markets.
At the start of 2012 Tideway felt the world was "recovering a little" so bought bonds from banks and insurance companies such as Bank of America, Lloyds, Barclays, RBS, Bupa, Legal & General and Standard Life.
"These ended up delivering an enormous return in 2012 of 30 per cent," says Mr Baxter. Tideway hedged them for a smoother return so made 24 per cent rather than 30 per cent.
While the fund has taken profits on a lot of these bonds, Mr Baxter says: "We won't go piling into the equity market".
One of the fund's investment themes for 2013 is the weakening pound. "Buying little blocks of foreign currency is difficult for the small investor. But we are buying a basket of foreign currencies." The 35 per cent exposure to global currencies to offset risks of falling sterling values includes US and Canadian dollars, Chinese Yuan, Malaysian Ringgit, Korean Won and Norwegian Krona.
Another theme for the fund is rising interest rates. "Interest rates will still continue to rise," he says. "The US will lead the way out of low interest environment. So we're building a position of being short US Treasuries."
While the fund has bought some utility bonds, Mr Baxter says it is not buying "15-year 4 per cent type bonds". Instead they are looking for yields above 6 per cent.
"In terms of fixed income, as long as governments keep base rates below 1 per cent if you're lower down the yield curve you can get a capital return. It's not just about yield," he says.
"People look at fixed rate returns and think 'it will just pay 6 per cent over 15 years'. In reality you get more than 6 per cent in the early years and less in the later years."
"We bought some very high coupon paying insurance bonds. Friends Life has a coupon of 14 per cent. We had to pay £1.25 for it which seemed expensive. In fact £1.25 went to £1.34."
He believes holding the bonds of a company is a lot less risky than owning the shares. "Bond holders have got all the share holders behind them first," he says. "So if you feel fairly comfortable about holding a company's equities, the chances are you will be very comfortable about holding the bonds."
James Baxter CV
James Baxter is managing partner at Tideway Investment Partners. He has 24 years of experience as a financial adviser and investment manager. Prior to founding Tideway, he managed his own company, JBCM, which now trades as Dart Capital, from a start-up in 1989 to £150m of funds under management at the time of its sale in 2008. He has specialist qualifications in pension advice, taxation, trusts and portfolio management
When a company is liquidated, its economic obligations are paid off according to a strict sequence. First are the expenses incurred as a result of the business's bankruptcy and subsequent transactions. Second is secured debt, meaning debt with attached collateral. Following that is unsecured debt, including most bonds. Shareholders come last after unsecured debtors, with preferred shareholders taking precedence over common shareholders. In most cases, there likely isn't anything left for common shareholders by the time that the corporation's other obligations are paid off.
The Tideway fund is small at £28m and expensive with an annual management charge of 1.95 per cent. However, Mr Baxter is critical of most of the fund management industry for just replicating what a private investor can do.
"You can buy equity exchange traded funds online. You can replicate a large portion of the FTSE 100 by buying HSBC, BP and GlaxoSmithKline. Buy a tracker and you've got 95 per cent of what the fund management industry is offering," he says. "It's much better as a fund management business to try to deliver what the man on the street can't buy easily. I doubt many private investors would have made 20 per cent out of fixed income last year."
Most of his company's clients are in their late 40s and 50s and "deeply cynical about equities". "For my generation the cynicism about equities is deeply entrenched because we've taken two hits: in 2000 and 2009," he says. "We will be cynical for the rest of our lives."
He concedes that equities in the very long term will be "better for inflationary times than cash". "If we were having equities at all we would be attracted to high dividend paying cash-flow companies such as Vodafone," he says. "The only real deterrent is that at the end of day it's a market. The only thing that sets equity markets is whether there are net buyers or net sellers.
"If you can rely on the yield of your shares, that is a good way to invest in equities. But either do it yourself or buy an Invesco Perpetual fund because we're not going to compete with those guys."
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