SG Asset Management's U.K. group is short duration across its portfolios in expectation that 10-year gilt yields will rise from current levels of 5.08%. "Our fundamental bond models suggest that bond yields need to rise in all major markets. In the U.K., we see 10-year yields of 5.5% as fair value," says Stephen Peirce, director and head of corporate bonds in London. Once yields hit 5.5% Peirce says SGAM will move to a neutral duration position.
Peirce anticipates the correlation between the shape of the curve and market level will begin to break down and expects long-dated paper to underperform. SGAM is not as negative on interest rates as the market, notes Peirce. The firm is targeting 4.25% for U.K. interest rates by the end of 2004, versus the market consensus of 5%. Still, long-dated paper should suffer as a result of increased supply and rising inflationary uncertainty.
Peirce predicts that increased cash flow into gilts could contribute to some undershooting of yields, possibly to the 5.25% level. He points out that various regulatory and risk-based factors could give rise to more investors holding long-dated gilts. For example, new capital requirements for insurers may force them to buy more bonds than equities. Similarly, another U.K. government initiative toward changing how companies calculate pension fund liabilities may also contribute to more cash flow into long-dated gilts.
Peirce says break-even protection is slim for highly rated paper and weaker credits fully price in an economic recovery. SGAM has had a bias towards single-A and triple-B credits throughout 2003. The firm is reducing its overweight in lower-rated credits, bringing its allocation in line with its benchmarks. Peirce says the firm is targeting less-volatile areas of the market. "Dull, predictable, reliable that's our current focus--structured issuance has increasingly met these requirements," he says. The firm has bought into numerous sterling-dominated public private investment deals.
SGAM manages £350 million in fixed-income assets from the U.K. and £65 billion globally. The firm uses a variety of benchmarks.
