MAY 2012 Appeal to the grassroots
Alliance Trust Investments aims to get closer to the client by offering the benefits of a boutique structure with the back-up of a larger organisation.
ROD DAVIDSON Head of fixed income, Alliance Trust Investments
There has been a bull market in UK gov- ernment bonds for more than a decade, and most investors have benefited from this rising tide. However, generating strong returns over the next decade may take an alternative approach. Alliance Trust Investments came to the market two years ago with its Monthly Income Bond fund, which aimed to use a differ- ent method to many funds in the mar- ket by redu cing the influence of the underlying index on total portfolio con- struction.
The team of Rod Davidson, Gareth Quantrill, Stuart McMaster and Stuart Steven joined Alliance Trust Invest- mentsfrom SWIP in 2010 to set up a bond boutique within the wider organisation. Davidson says the team believed that the way liquidity in bond markets was moving, it would lend itself to smaller fund groups. Also, having worked for larger organisations, the group was keen to concentrate more fully on actual fund management and bring themselves closer to the clients again.
This structure has all the natural advantages of a boutique, with the back- ing of a larger organisation.
Davidson says: “The team all have strong accountability for the fund’s per- formance – it is the only fund we run at the moment, so we can only thrive through its performance. We all invest in the fund. But most of all, the structure at Alliance Trust Investments allows us to deliver exactly what clients want, and to speak to them more frequently, giving our real-time thoughts on market condi- tions and potential outcomes.” He explains the group’s philosophy: “Our main competitors are the very large organisations and we are almost trying to be the antithesis of these while respecting what some of them have achieved over the last 10 years. “Having substantial assets under management (AUM) in today’s market conditions has become more of a hindrance than a benefit with regard to producing expected returns on a con - sistent basis. I was a head of department for some of the major fixed income groups and found that as AUM and
teams grew I moved a long way from the grass roots of a being a fund manager and delivering results.
“There has been a lengthy bull run in the bond markets (bar a few macro and credit-related events) and the next few years will require a more nuanced approach to investment. The corporate bond sector was £1 billion in 1992 and it is now over £50 billion, with behemoth funds and groups dominating the sector. Even though we are not at a turning point yet in the interest rate cycle, man- aging against a conventional benchmark may not prove to be the optimal position from an investor’s point of view.” The Alliance Trust Monthly Income Bond fund is managed with the recogni- tion that there is a significant demand among investors for income. At launch, it was designed to have as much flexibil- ity as possible, and while it sits in the corporate bond sector, it is almost “strategic” in its approach. For example, it has a strong duration management pro cess, holding a sub-index duration position since launch. If the managers believe interest rate policy is about to turn and rates are likely to move higher, the fund’s duration or interest rate sen- sitivity is likely to be reduced. The man- agers can take this position to zero if they have a strong conviction. Davidson adds: “Looking ahead, we think investors should focus more closely on the income component of their bond fund holding. They have had some good capital gains over the last 15 years but these will be harder to replicate over the next 15. Within the fund, as well as focusing on interest rate risk and preser- vation of capital, income management is an important element of our strategy. Since launch we have delivered an annual yield of 6%*, distributed monthly, which is high compared to our peers in the corporate bond sector.” However, Davidson wants this yield to be achievable, sustainable and con- sistent. This means the managers carry out this strategy while targeting an aver- age rating in the fund of no lower than single A and only a small allocation to high yield. He considers that as some funds in the sector have got larger it has become increasingly hard for them to focus on income. “We recognised that if we focused on the belly of the yield curve we could generate a higher income for our investors while overlaying our dura- tion management strategy separately through the use of futures.”
This has meant a higher weighting in banks and other financial companies such as insurers, and David son still sees value in this sector as many of the man- agement and regulatory strategies are designed to support bondholders. Own- ing bonds higher up the capitalisation structure should provide good returns over the next few years. “This strategy means that over the past 12 months the fund has experienced some volatility, but the peaks and troughs have lessened over the last few months and we don’t expect to endure the same level of unit price volatility suffered last year.” In this type of area, credit analysis comes into its own. Davidson says: “We have significant experience in credit analysis. Our aim is to find value in the market and ensure we can get the posi- tions we want. Then, when we reach a more fully valued position, we might sell these holdings and find something more interesting to invest in.”
The fund has a relatively concen- trated portfolio, with about 66 names at present and a target on the upside of about 100 names. The team expect to close the fund at around £1 billion under management. It is about £230m at the moment. Davidson says this aims to take advantage of the present liquidity con- ditions in the credit market and limits the average position size in the fund when it peaks to about £10m.
‘ ‘
There has been a
lengthy bull run in the bond
markets and the next few years will require a more
nuanced approach to investment
Issuance is still weak in the corporate bond market. Industrial companies are well funded and there is little need for them to come to the market. Even in financials, issuance has been lower than expected and potential borrowers are expected to be focused more on issuing contingent convertible bonds than con- ventional bonds over the next few years. Davidson says: “In the future, bond fund managers will look to introduce greater flexibility in their mandates to best position themselves for the prevail- ing market conditions. Feedback we have had from the market about this issue suggests that this strategy is find- ing resonance among investors.” *The distribution yield reflects the amounts that may be expected to be dis- tributed over the next 12 months as a per- centage of the mid-market unit price, and is based on a snapshot of the portfolio as at March 31, 2012. It does not include any preliminary or annual charge. Investors may be subject to tax on distributions. The yield is not guaranteed and may fall below any figures stated in this document.
FUND PROFILE
25
www.alliancetrustinvestments.com
ati@alliancetrust.co.uk WEBSITE
08082 341 888 EMAIL
PHONE
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