After the very weak last quarter in 2018, the bond markets staged an exceptional rebound this year powered by the Fed’s changed rhetoric indicating a pause in the hiking cycle. Corporate bond indices rallied hard - investment grade bond indices were up between 3-5%, European and US high yield indices were up in excess of 5%-7% to the end of March 2019. Government bonds have performed strongly as well, with Bunds and Treasuries returning c. 2% and UK Gilts, due to their longer duration, outperforming with approx. 3.5% over the first quarter.
The MISM bond fund did well to capture this rally, returning 4.3% versus fund’s benchmark’s* total return of 4.1%. This marginal outperformance has been generated by the corporate bond allocation of the fund, with Pimco manager accounting for the larger part of outperformance.
The allocation to government bonds within the MISM Bond fund is broadly in line with strategic asset allocation which is comprised of 28% in the FTSE All Stock Gilts, 14% in Index-linked Gilts and 57% in Markit iBoxx Sterling Corporate Bond indices. We currently favour conventional gilts over index-linked gilts. Index-linked gilts are pricing in inflation expectations well above the Bank of England inflation target hence do not offer much value and could be vulnerable to weaker inflation data. The UK inflation, which has risen predominately due to a weaker pound over the last couple of years, is now printing close to the Bank of England target of 2% and is likely to remain there for the rest of the year.
The fund is slightly underweight corporate bonds, approx. 1%. The corporate bond allocation also contains an off-benchmark position in a global credit strategy managed by Robeco, which is dominated by US dollar denominated investment grade bonds.
Robeco managers added the risk into the portfolio during November and December last year capturing higher yields as the corporate bond markets sold off. This strategy paid off this year with majority of returns generated by overweight to credit beta. During March the fund managers started taking profits and moving up the quality scales.
Pimco’s mandate is similarly overweight credit risk but predominately in the UK, favouring UK banks and asset-backed securities. The recent results of the Bank of England stress test confirmed the resilience of the sector, highlighting the capital strength and liquid balance sheets in the UK banking sector.
Both corporate bond fund managers now are reducing risk exposure within their mandates cognisant of the maturing business cycle.
*The fund’s benchmark is comprised of 50% FTSE All Stock Gilts Index and 50% In Markit iBoxx GBP Corporate All Maturities index.
Past performance is not a guide to future performance.
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