Fund Manager Briefing: Henderson Strategic Bond Fund

Lipper’s Jake Moeller presents highlights of a presentation by Jenna Barnard and  John Pattullo, fund managers, Henderson Strategic Bond Fund, on August 5, 2014.

Reuters/ Vasily Fedosenko

Co-manager arrangements seem to be quite common in the bond fund space; think Paul Read and Paul Causer at Invesco Perpetual or James Foster and Alex Ralph at Artemis. Perhaps one of the most enduring pairings would be John Pattullo and Jenna Barnard, who have worked together for 11 years at Henderson and preside over one of the U.K.’s best known bond funds: Henderson Preference & Bond Fund. As co-managers of the Strategic Bond Fund, they are about to experience their first temporary separation, since Ms. Barnard takes maternity leave from September this year until February 2015.

Views on the efficacy of the co-manager structure vary. Some see it as a potential dilution of accountability; others see it as an effective spread of key-person risk. The evident seamless interaction of Ms. Barnard and Mr. Pattullo is possibly one of the most striking features about their dynamic. They don’t specialise in particular areas as some duos do, but neither are they in a constant state of consensus; it is the evident trust they have in each other’s decision-making that makes this pairing so robust.

Ms. Barnard’s temporary departure is undoubtedly of concern, since the subtle dynamic of the team will be disrupted, but Henderson is a large, well-resourced house. Dedicated analysts already established in the process such as Nicholas Ware, Rebecca Morris-Charles, and Arjun Bhandari are well placed to augment Mr. Pattullo’s considerable experience. Given this fund has a very low turnover and the central thesis of the managers is a benign outlook for bonds in the next 12 months, not much may have changed upon Ms. Barnard’s return.

Table 1. 10 Year Performance and Henderson Strategic Bond within Sector Quartiles

Source: Lipper

A low-growth, -inflation, -volatility, and -default environment creates what the managers see as the “perfect carry environment,” where reliable yield rather than extraordinary capital appreciation should be foremost in investor expectations for the foreseeable future. This doesn’t mean torpor. August  1 saw the U.S. high-yield market reprice from 5.0% to 6.1%, with cumulative net outflows of some US$ 11 billion from retail funds on the back of comments made by Federal Reserve Chair Janet Yellen. Mr. Pattullo points out that, by comparison, last year’s “taper tantrum” saw net outflows of US$14 billion. The August wobble was driven mainly by extreme valuations rather than traditional factors (such as Treasuries selling off or an increase in defaults). The intense news coverage was in relation to hotter assets in exchange-traded funds and retail holdings, which actually represent only a small percentage of the overall high-yield market.

Tactically, Pattullo and Barnard were able to benefit from this market anomaly. Because of high levels of cash in the fund (13%) and strong inflows, they did not become forced sellers and were actually able to add risk to the fund. They did that by increasing by 2% the credit beta exposure of the fund via derivatives on the iTraxx Crossover Index (which is both highly liquid and cost effective). Only one working day later they were able to reverse some of this position at a profit. Neither manager ignores potential benefits of derivatives usage. Indeed, at the peak of the credit crisis in 2008 they successfully used derivatives to insure their portfolio against credit risk, adding 750 basis points. Ms. Barnard points out that in the Strategic Bond Fund, derivatives turnover in the portfolio is six times greater than the physical book of assets.

Table 2. Risk/ Return Profile of Funds within IMA £ Strategic Bond Sector

Source: Lipper

Strategically, the managers have been operating two levers–benefitting amid the gilt “pain trade” (falling yields despite monetary-tightening expectations). They added gilt exposure in September 2013, identifying value after examining five-year forward rates and noting excessive short positioning among investors. This held them in good stead at the beginning of 2014 when many others were hurt. More materially, they have benefitted from their second lever, credit selection. They hold a surfeit of the now-legacy long-dated Tier 1 bank securities. They acquired these before banks such as RBS and Commerzbank tendered to get the bonds back in favour of the loss-absorbing contingent convertible securities (CoCos) preferred by regulators. They have also identified opportunities in the area of fixed line/mobile phone convergence being driven by increasing M&A activity.

It hasn’t all been plain sailing though. Despite the tactical win over the August wobble, July was a difficult month, since both managers have a predilection toward the larger high-yield deals with a lower probability of default. With the increased liquidity, these were hit hard by the indiscriminate selloff. Similarly, doing well in January’s “pain trade” left them underweighted in government bonds in July. This, however, was a position with which they still feel quite comfortable, despite the sudden risk-off event, simply believing high yield offers better value.

At its core Henderson Strategic Bond is a very conservative fund, much like its Preference and Bond sister. Mr. Pattullo and Ms. Barnard are very conservative fund managers, and for those investors seeking yield, this is to be commended. In this benign low-interest-rate market the biggest risks occur as the temptation of yields of 6%, 7%, or even 8% force the unwitting investor into illiquid assets, placements, unrated securities, or elaborate structured products. Ms. Barnard and Mr. Pattullo are under no pressure to seek yield such as this.