Defensive Bond Fund Strategy launch-pad for special opportunities

Even after the recent widening of credit spreads, Karl Bergqwist and Simon Surtees, Gartmore’s co-heads of fixed income and co-managers of the Gartmore Corporate Bond Fund and the Gartmore High Yield Corporate Bond Fund, continue to position their investment-grade funds defensively, with “overweight positions in government and supranational bonds of the highest credit quality.”

However, their decision last week to invest in Bear Stearns’ debt, described as a “convergence trade”, is a clear example of how a defensive position can be used to take advantage of selected investment opportunities as they arise. None of Gartmore’s fixed income funds had investments in Bear Stearns’ bonds prior to the events of last week.

In theory, provided JP Morgan’s rescue offer for Bear Stearns proceeds, the bonds of the latter will assume the same credit risk as JP Morgan’s debt and should trade at a similar yield premium over US Treasuries. This is because JP Morgan has agreed to absorb Bear Stearns’ entire capital structure, thereby affording protection to the latter’s preference share and subordinated bond holders.

The risk is that Bear Stearns’ former shareholders disrupt the transaction, however, according to Karl and Simon, this possibility continues to be reflected in the fact that Bear Stearns’ bonds are trading wider than those of JP Morgan even after recent gains.