The M&G UK Inflation-Linked Corporate Bond Fund (GB00B460GC50) suffered in 2014 as a result of rapidly falling inflation rates and a short strategy which took its toll on performance. But manager Ben Lord believes the fund, an IC Top 100 Fund, will come into its own this year and says inflation could even surprise on the upside in 2015.
Mr Lord "hated 2014". The fund, designed to offer protection against inflation and rising interest rates, posted a total return of minus 1.2 per cent for 2014 as inflation rates tumbled. The fund's one-year return to the end of January 2015 was worse at minus 2.1 per cent.
Pushed down by the drastic slump in the oil price, Consumer Prices Index (CPI) inflation dropped to a 12-year low of 1 per cent in November 2014, down from 1.9 per cent in January 2014. It then plunged even further to a record low of 0.5 per cent for the year to December 2014.
"I'd be lying if I said I hadn't been shocked," says Mr Lord. "I didn't see the collapse in the oil price coming." However, he puts the fund's performance throughout 2014 down to his short strategy and a slide in gilt yields. "I started the year thinking that gilt yields were too low and that they would probably move higher."
In fact, gilt yields moved lower and a series of short positions taken by Mr Lord meant the fund lost out and were the "main driver of poor returns", he concludes.
However, Mr Lord avoided some of the impact of sliding inflation rates as he spent 2014 reducing the fund's exposure to UK inflation-linked bonds, taking index-linked exposure down to 70 per cent of the portfolio in the middle of the year.
Mr Lord says: "We took exposure to index-linked bonds to the lowest level we'd ever been at since the fund was launched and only started adding again in November and December." That move was motivated by his observation that UK inflation protection looked expensive relative to US and European bonds.
Ben Lord CV Ben Lord joined M&G in 2007 and was appointed fund manager of the M&G Global Corporate Bond Fund from launch in September 2013. He is also fund manager of the M&G UK Inflation Linked Corporate Bond Fund and deputy manager on four other M&G funds. Mr Lord previously worked at Gordian Knot as a credit analyst covering global financial institutions. He has an MA (Hons) from the University of Edinburgh and is a CFA charterholder. |
But the fund's most dramatic move was its entry into negative duration for the first time ever, at the end of 2014. Duration is a key measure of interest-rate risk, with longer duration bonds the most exposed to moves in the rate. Motivated by the conviction that bond yields were "ridiculously expensive" the fund moved from two-year duration at the start of 2014 to a negative duration in December and now stands at a modified duration of -0.4.
"Massive central bank balance sheet expansion trumped everything and I asked myself do I need to go back to neutral? Should I go long?," says Mr Lord. "But I was asking at all the wrong times."
He believes that the move to negative duration could prove a boon to investors. "If we do start seeing yield curves increase, the fund will behave in a different way to a typical bond fund, and that [short] duration which cost the bond fund in 2014 may start to pay back," he adds.
He also thinks inflation numbers "could surprise on the upside" over the course of the coming year. "There is a lot of deflationary concern out there, which is hard to ignore. But the mechanics of the inflation numbers suggests that by the second half of this year you could start seeing decent improvements," he says.
"Not all that many funds out there have negative duration and it should be an interesting differentiator for 2015. I think inflation protection looks cheaper than it has done for a long time, which means there's a decent chance that, over the course of 2015, inflation-linked bonds will outperform nominal bonds."
However, he has held back from taking the fund to 100 per cent exposure in index-linked bonds due to the potential of buying more in the event of another negative CPI figure. "There may be people desperate to sell inflation-linked bonds and it's on those days that I will be able to get really attractive entry points," he says.
Tesco remains the fund's largest issuer alongside National Grid, Wells Fargo and Lloyds Banking.
Last year the fund added exposure to American banks including Bank of America and JPMorgan. The fund also added credit risk in the form of credit default swaps with several companies including Reynolds American.
"We've got a lot of exposure to European credit and were trying to close out the underweight in US," says Mr Lord. "The US doesn't tax oil use to the same extent that Europe and the UK do so if the oil price falls the consumer gets much more of that benefit at the pump than we do over there."
That also influenced his decision to take 15 per cent exposure to Treasury inflation-protected securities (TIPs). "In November and December we were switching out of five-year gilts into TIPs for the best terms that had been seen." He argues that front-end TIPs will experience any positive impact from an oil price pick up before other securities.
