New Star says forget fixed income for 2007

Theodora Zemek, head of fixed income strategy at New Star and one of the most well-known fund managers in the UK, gave quite an alarming, if passionate and transparent, outlook on fixed interest for the new year. “We have had a 25-year downturn in interest rates and we have had a very good ride for our money, but all trends come to an end,” stated Ms Zemek, who has 20 years’ experience as a fund manager and is currently rated “AAA” by mutual fund tracker Citywire. Not even derivatives, which are increasingly employed by large fund houses such as Pimco or ABN Amro to supposedly spice up returns, will make any difference to the gloomy scenario, according to Ms Zemek. “Just to keep the faith and money rolling in, there will be those who say they can magic up all sorts of wonderful returns using derivatives,” she warned. But she said there is no evidence in the market to support this claim. Ms Zemek, who launched the first corporate bond and the first yield corporate bond fund in the UK, while working for M&G Investment Management as head of global fixed income and chief investment officer, said she had never been tempted to use derivatives in her fixed income funds. “In fixed income you do not have to do anything exotic to have an acceptable return, just pulling in your bets and cash-related instruments.” Her target is to deliver a better return than that offered by building societies, or the same return in a difficult market. Ms Zemek manages the New Star fixed interest unit trust, rated “AA/V3” by Standard & Poor’s (S&P), which reported a 4.5 per cent total sterling-based return over the last year versus 3.9 per cent for the S&P sector average. The fund also outperformed the sector in the last three years, delivering 22.8 per cent versus 21.9, while underperforming in the past five years. The “AA” S&P rated New Star Managed Distribution fund, also run by Ms Zemek, combines bonds with income-bearing equities, which represent a percentage not higher than 40 per cent of total assets. The fund strongly outperformed the S&P sector average, reporting 12.4 per cent return versus 5.7 per cent over the past year and 40.9 per cent versus 31.7 per cent over the past three years. The higher return is explained by the equity components in it, and includes an income cashflow, explained Ms Zemek. But, as the other multi-asset income fund that the firm offers, the New Star Tri-Star Unit Trust investing in bonds, equities and commercial property, the product represents “a step further out the risk scale”. Showing higher volatility, it cannot guarantee the “predictable income stream” that retail investors look for in this traditionally safe asset class. Government bonds Looking at the UK market, Ms Zemek favours corporate bonds, particularly “weaker credit corporate bonds” because profitability remains high and cashflows are strong. On the contrary, we can expect a “nervous and volatile government bond market, at best”, she said. At worst there is going to be “a very sharp sell-off”. The level of income that investors get from a long-dated government bond is almost not enough to cover inflation, she said. “The UK economy is strong and inflation will go up,” predicted Ms Zemek, who in December also forecasted the quarter-point rise in interest rates, which a month later brought the UK interest rate to 5.25 per cent, surprising most economists, in an effort made by the Bank of England to get inflation back under control. Meanwhile, UK inflation rose to an 11-year high of 3 per cent in December, above the average for the European Union as a whole, thus raising the prospect of more interest rate increases. “We have had a very bad year in bonds in 2006,” said Ms Zemek. “We are hoping to whether the storm, which we did very well in 2006. But I think the storm is going to continue in 2007.” Perhaps revealing a sort of internal conflict, Ms Zemek admitted that, as an investor, she would undoubtedly favour equities in her portfolio. “I would certainly overweight equities rather than bonds, in the UK and most markets. I am expecting bonds to be fairly light blustered.” Against the opportunity to “mess around with bond hybrids”, Ms Zemek said that, as a bond manager she “cannot do much”, just go up to her maximum in her managed distribution fund and have as much as possible in high-yield corporate bonds, which she is doing. For greater returns, Ms Zemek suggested that investors look also at alternative investments, for which “it is going to be a very good year.” She announced that together with her colleague James Gledhill, head of fixed income credit and manager of the New Star High yield bond fund, she is going to manage a new hedge fund the firm is set to launch this year.

Zemek: 2006 was a bad year for bonds