Why Being Too Cautious on Bonds Lost Cash in 2015

Axa Distribution manager Richard Marwood called the end of the bond rally too early but says now we are poised for a rate rise, his potfolio is perfectly positioned

Emma Wall 16 December, 2015 | 4:01PM
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Emma Wall: Hello and welcome to the Morningstar series "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Richard Marwood, Manager of the AXA Distribution Fund.

Hi, Richard.

Richard Marwood: Hi, Emma.

Wall: So, AXA Distribution Fund this year has been a bit of a sticky year. Previous years you've been looking at very nice positive performance. But this year I think you've lost about 1.5% and I think that's interesting because it's a cautious portfolio, great for a sort of center of someone's portfolio around which they can take more edgy bets and a cautious portfolio should have done well this year because it's been slow growth, no growth and volatility. So, what happened?

Marwood: Well, I suppose there are two areas where we look to generate return. Firstly, on the equity side and actually, the equity market hasn't made a great deal of progress really in 2015. But more interestingly on the other side we're quite defensively positioned actually on the bond portfolio. The portfolio is primarily in index-linked gilts and primarily at the shorter end of the duration curve.

So, it is very, very defensive and actually in a world where people have still been really quite positive on bonds a bit more credit risk and a bit more duration would have been helpful. But actually we want to keep the defensiveness there. So, we haven't changed our stance at all, but we have paid a price for being cautious in the bond market.

Wall: And you weren't alone there. At the beginning of 2015 – indeed at the beginning of 2014 everybody called the end of bonds, but it carried on going until today probably because we are talking on Wednesday morning and it looks like the Fed is going to raise rates this afternoon. Does that mean that you're now perfectly positioned for the future?

Marwood: Potentially yes. I mean, I wouldn't want to put any more risk into the bond portfolio which is why we've kept the positioning that we have. I suppose longer-term the thing that we need to see is actually what's going to be the longer-term situation with interest rates and then inflation as well because inflation has been very, very muted so far this year and I think we just need to look at longer-term how much inflation protection you need.

I would argue even though we sit here at the moment with no inflation, I think we will have inflation at some point in the future and inflation protection will be important.

Wall: Because over the next six months we are, of course, going to see the benefit of oil prices falling flip out of that inflation measurement.

Marwood: Precisely, yeah.

Wall: So, what when that happens will you be looking to do?

Marwood: Well, we'll be staying in the similar position in terms of focusing on the index-linked gilts. But you're quite right, the base effects will come out and we'll start to see inflation trending up. I think the other thing that's going to be interesting is what happens with labour rates and wage growth because there is a bit more talk now of about actually having real wage growth and some of it will be mandated from what we saw in the budget with the living wage going up. So, I can see reasons why inflation will start to tick up.

And clearly, if the oil prices were to recover at all then the deflation we're seeing from the oil price falls would start to reverse and become inflationary again.

Wall: Of course, as you say, bonds only make up a part of the portfolio. Equities is the other part. This has been a pretty disappointing year for U.K. equities. Going forward, should we expect to see more of the same?

Marwood: I can see sort of two poles really on the equity market. One of the positive things that we've seen this year has been lots of takeovers and I think we'll carry on seeing more takeovers as we go into next year which is clearly going to be a positive for the market. The things that makes me a little bit nervous on the other side is one of the big bull cases for being in the equity market at the moment is that there is more income available from there from taking dividends rather than compared to low bond yields and dividends are coming under pressure.

So, we're seeing companies passing dividends altogether, dividends being cut, a lot of that being driven by weakness in the commodity markets and that's the area I'm just a little bit cautious on. So, I think a lot is going to come down to what does happen in commodity markets because that's going to have a bit impact on dividend payments from the U.K. equity market next year.

Wall: Richard, thank you very much.

Marwood: Thank you, Emma.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar