Emma Wall: Hello and welcome to Morningstar. I’m Emma Wall and here with me today is Rathbone's Ethical Bond Fund manager, Bryn Jones.
Hello, Bryn.
Bryn Jones: Hi, how are you?
Wall: So, firstly, I'd like to congratulate you on your Morningstar Fund Manager of the Year Award.
Jones: Thank you.
Wall: This is the Ethical Bond Fund which is quite a unique offering, isn't it? There's only four ethical bond funds I think in the market available to retail investors. What exactly does that mean? Is that screening out certain bonds?
Jones: Yeah. So, we have a negative and a positive screening process; so, where negatively screened things first of all. So, if it has one negative, it doesn't go into the fund. So, these are things like tobacco, alcohol, pornography, gambling, mineral extraction, car manufacturing. So, any of those, the bond won't go into the portfolio. But then after we've done the negative screen, if it hasn't had anything negative, will end to a positive screen which could be things anything from along the lines of environmental or social, normally sort of the ESG (environmental, social and corporate governance) things that you'd be looking for from a good company.
Wall: I mean, the bond market is facing challenges at the moment, you are being able to find yield in a sort of smaller and smaller bucket of bonds. Is the screening reducing that even further?
Jones: No. The screening does take out some assets. But over the last sort of 10 years that I've been managing the fund, it's helped protect us from some issues that have occurred from companies that have had bad governance. So, okay, the universe is smaller, but at the same time it can help protect you from businesses that potentially can get litigated against quite badly.
Wall: I know that you don't hold any gilts because of the armament link, which are gilts, of course, one of the fixed interest assets that are most sensitive to interest rate rises, but all bonds are in general, aren't they? And we've reached this impasse now where we are not sure exactly when interest rates are going to rise, but most people agree it's going to happen in the next 18 months. I mean, where is your view on that?
Jones: Well, if you look at the short-term interest rate futures curve, the rate rises have been impressive; first rate rises 25 bps in November of this year of 2014. And then another four rate rises next year, each around the quarterly inflation report, which would take the interest rate in the U.K. to 1.75% by the end of 2015.
With gilt yields currently in the 10-year area, so 2.6%, 2.7% and possibly moving maybe towards 3% if people stop pricing in further rate rises. Actually at 3% we think they might actually start looking a little bit attractive, because we don't think interest rate policy will get rates to 3% anytime soon. We think that the housing market will start to struggle if base rates went to 3% and we also think companies will struggle to refinance much higher underlying gilt yields. So, we are buyers of something called duration if gilt yields rise across both our Strategic and our Ethical Bond funds.
Wall: So, interest rate rises maybe a positive thing for bond investors?
Jones: Yeah. Well, one thing is if yields do rise you ultimately can buy into an asset which has a higher yield. But of course, on the marker-to-market basis, yield rises are negative for bonds in capital terms. So, what we've tended to do is we're trying to hide in assets which are protecting us from that potential risk, with a view of flipping out those into high yielding assets when yields do rise.
Wall: Bryn, thank you very much.
Jones: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
