What is the Kame Absolute Return Bond Fund?
It’s a low-risk, fixed-income fund that aims to generate steady, positive total returns in all market conditions.
The fund is structured on three investment modules: carry, rates, and credit. Each of these invests in different parts of the fixed-income market to add value in their own way.
The carry module makes up 40% to 45% of the fund. It’s a diversified collection of short-dated, high-quality, low-risk corporate bonds that generate modest income. I like to think of it as the foundation of the fund – it’s not looking to do anything heroic.
The credit module makes up about 25% of the fund. Here, two company bonds in the same sector are bought and sold as a pair to neutralise any long or short credit risk. With traditional fixed-income investing, for example, you would find a company you liked and buy the bonds – if the price goes up, you make money; and if the price goes down, you lose money.
But if you’re long in one company and short in another, then you benefit from the relative performance. In the past, we’ve taken exposure to two different UK banks – we were long in RBS and short risk in Lloyds Banking Group.
Finally, the rates module makes up the last 25% of the fund. Here, you’ll find government bond-related positions. Bonds are linked in pairs.
For example, until this morning* we were long in US Treasury futures [a type of bond] and short in Australian futures. We made money as while the Australian bonds underperformed, the US bonds held their own. The remainder is held in cash.
How do you decide what bonds to buy?
When buying bonds for the carry module, strict criteria must be met. The bond has to have less than two years until maturity, and its credit risk has to be rated as BBB- or above. This ensures we’re buying bonds with low sensitivity to movements in interest rates or credit spreads.
We also look for bonds paying yields in excess of Libor [the benchmark banks use to lend to each other] – which is 0.35%*.
With our pair trades, we want to determine whether two assets that may be the same on face value have similar risks. We will research the individual companies or economies to see if the bond should be cheaper and we will put in a trade to reflect our view of where prices might go.
How long do you usually hold bonds for?
This varies. Bonds in our carry module are held for two years or less. In our rates module the average hold is two to three months, though some last a couple of weeks and others six months. In our credit module, the average holding is three to six months, though a bond could be there for a month to a year.
What bonds have you recently bought and sold?
We’ve recently bought US Tips (Treasury and Inflation Protected Securities). These are a bit like index-linked bonds, and we sold government bond securities at a similar time. This is because we’re looking to take advantage of an expected rise in inflation – both globally and in the US.
We think US rates will rise beyond what the market is expecting, which means you’re better off holding an inflation-linked bond.
On the corporate side, we’re long in Jaguar Land Rover and short in Peugeot. We think Peugeot is under intense pressure and we question its credit quality. Jaguar Land Rover, however, has a much better-run business, and we expect it to be on better form in the period ahead.
We’re also long in Societe Generale and short in Standard Chartered Bank. Societe Generale has been underperforming due to upcoming French elections, but we think the risks are overplayed by the market.
The fund aims to return 2%-3% above Libor. Why hasn’t it achieved this?
Action from central banks since our launch has meant yields, credit spreads and volatility have been depressed and suppressed. We’re looking for volatility, as this opens more opportunities. But we won’t increase risk to chase higher returns.
Can bonds continue to perform well for investors?
Yes and no. It’s unlikely bond yields will go down to a lower level than they have been over the past 12 months. The direction over the next two to three years is higher, but a bull run continuation is unlikely.
Gilt [UK government bonds] yields, meanwhile, are 1.25%* , and I don’t think they’ll be at 3% for the next 12 to 18 months. So while easy money has been made, and going forward it’ll be more challenging, it’s not the death knell for fixed income.
What’s your top tip for a first-time investor?
Do as much research as you can, know what you’re buying and diversify your exposure. You should also invest for five to 10 years-plus.
The man behind the fund
Colin Finlayson (pictured above) co-manages the fund with Stephen Snowden. Colin joined Kames Capital – the investment group behind the fund – in 2000 directly from the University of Strathclyde, where he studied economics and finance.
Stephen, meanwhile, started his career at Kames Capital in 1994 before leaving and rejoining in 2011 from Old Mutual Asset Management. He has both a degree and a Masters in Finance from Queens University Belfast.
Kames Absolute Return Bond Fund key stats
Launched: September 2011
Fund size: £1,939 million
Ongoing charges: 0.68%*
Source: Kames Capital factsheet, 31 January 2017.
*Based on the year ending 31 December 2016.
Sector allocation, five year performance and top 10 holdings
Click on the image below to enlarge: