A GOOD ALTERNATIVE TO HOLDING CASH

The Deutsche Lion Bond Fund aims to deliver returns that are above current fixed deposit rates. So far, the fund, which seeks to invest in bonds rated at least a single 'A', has achieved that - surpassing fixed deposit rates by more than one to 1.5 per cent since its launch. Year to date as at October 17 2002, the fund has returned 4.1% net of fees. This is about 2.8% higher than what an average 12-month fixed deposit offers right now.

Phoon Chiong Tuck, chief investment officer of Deutsche Asset Management, believes that the fund has managed to deliver these returns because of their active management style. Most investors think that bonds are inherently safe assets, but they can be volatile as well. In fact, when interest rates rise, longer-term bonds get hit more severely, and investors could get disappointed by their returns, he cautions. And should economic fundamentals get weaker from current levels, bond yields will come off.

However, Chiong Tuck figures that yields will probably be range-bound for now. In fact, it is likely for yields to increase, as interest rates are at one of its lowest points and could be raised anytime. Over the last one to two years, bond prices in the US have skyrocketed and yields have come off significantly as interest rates have been systematically reduced to counter inflationary effects.

But this does not mean that rates will definitely go up, notes Chiong Tuck. The Fed's bias on easing, coupled with still mixed signals that the US economy is sending out, means that rates will probably stay unchanged at the next Federal Open Market Committee meeting on 6 November 2002. He thinks that this environment of low interest rates will stay for some time yet.

Even so, volatility has become embedded so deeply into global stock as well as bond markets that it is important to manage the risks involved. Volatility is a concern, especially in the US where stock market rallies over the last two weeks have caused bond yields to come under pressure.

The Lion Bond Fund is keeping to a shorter duration of two years or less at the moment. Duration is a measure of interest rate risk. If the fund manager thinks that yields will rise, they will keep to a shorter duration so as to take advantage of rising interest rates.

Is deflation looming?
Global interest rates are at one of their lowest points. Japan's interest rates are at zero per cent. The country has had deflation for several years now. In the US, the federal reserve has reduced short term interest rates successively by more than 400 basis points to current levels of 1.75%.

Singapore's interest rates have also moved in tandem with global rates. At levels around 1%, the three-month Singapore interbank offer rate, or SIBOR, is at its lowest in more than 10 years.

The rise of China and its cheap labour has caused significant pricing pressure on the supply side, while the tapering demand from consumers, the US in particular, has let off most of the hot air on the demand side. Deflationary forces are evident, observes Chiong Tuck, but policymakers and central banks will probably do what they can to try to counteract this. "The backdrop for deflation is there, but this does not mean that it is inevitable."

Although the Lion Bond Fund can invest in bonds from G7 countries, Australia, and New Zealand, Singapore bonds feature strongly in the fund's top 10 holdings based on their latest factsheet as at 30 September 2002. Upperton (securitisation of Wisma Atria building) (7.1%), Keppel Land (6.3%), NTUC (5.7%), Allgreen Properties (5.2%), United Overseas Land (5%), SMRT (4.3%), SingTel (4.1%), and Centrepoint (4.1%) are those favoured by the fund manager for their attractive yields and relatively safe credit standing. Deutsche has their in-house credit assessment for Singapore bonds, which are mostly unrated.

The Lion Bond Fund is probably one of the more familiar names among the list of bond funds available to investors. Launched in 1997, the fund size has grown steadily to approximately $132 million as at 17 October 2002. This year alone, the fund has seen additional inflows of $50 million.

So will 2003 be a good year for bonds? Chiong Tuck thinks that it will be, although returns will not be as spectacular as 2001 and 2002. The Lion Bond Fund looks set to chalk up net returns of 4% or more for the rest of this year. At these levels, it is certainly more attractive than leaving your money sitting in your bank account.