17th June 2008

Thames River Capital - Strategy shift into Bonds and Japanese Equities

• Our first move was to add positions in the M&G Leveraged European Loans Fund at the end of April to Balanced, Cautious and Distribution. This is a monthly dealing fund with exposure to secured floating rate loans that rank in the first tier of the borrowing companies' capital structure. These bonds have traded at close to par for many, many years, but fell victim to the credit crunch in disproportionate fashion as they were squeezed at both ends by the geared hedge funds that bought them and were forced to sell. Also, the banks at the other end who were tending to use these loans to finance private equity, were holding them on their balance sheets ahead of selling on to these hedge funds. We have been waiting for signs that this overhang was removed and we believe that this has now occurred. This fund offers managed access to this specialised area, normally used in the main by pension funds and of course, it provides diversification. We are also hopeful for capital uplift.
• Our second significant move came recently when bonds were increased as follows: Cautious Managed bond weighting increased from 31% to 49.5% (sector average 48%), Distribution from 36% to 49% (sector average 48%), Balanced from 10.5% to 18% (vs. sector average of 15.5%). This has been achieved by adding a further fund, M&G Optimal Income fund, managed by Richard Woolnough. It is a go-anywhere fund currently with a bearish view on the economy. We have added to existing holdings but favouring, in particular, pure corporate bond funds from Invesco and Old Mutual.
• The rationale is that bonds had been less attractive vs. cash due to the prospect of increasing defaults, insufficient yield pick up relative to cash, and severe illiquidity in markets. We now believe that default rates are priced in, at least for now, yield pick up is worthwhile and we have seen signs that liquidity conditions are over the worst. At the same time, almost all bond fund managers have been stating how cheap their market is with comments such as equity returns with bond risk etc. On speaking to a number of managers, we have satisfied ourselves that it is worth moving from the certainty of cash in exchange for the potential for capital uplift and some yield pick up currently offered by bonds. This may be something we reverse over the next six months if we see the capital uplift we expect and base rates are not cut further, but for now we want to be overweight in our peer group rather than the extreme underweight towards bonds we have been pursuing.
• Funding – this move has largely been funded from cash and from small reductions in funds like DDQ Income and BlackRock Absolute Alpha.