The bond market has continued to perform above expectations. We believe that the main reason behind the strength in bond prices is the fact that central banks around the world have expressed their desire to stay the course on their record low administered rate policy, until such time as the economic recovery becomes more firmly entrenched. This stance has forced fixed income investors out of the yield curve in their search for relatively high yields, with more confidence that low short term rates are likely to remain so for an extended period of time. There has also been an infusion of investment funds into longer term bonds from the developing nations, China and India in particular, enabling the heavy U.S. treasury calendar to be relatively easily absorbed.
The beginning of an economic recovery has not spooked the bond market, as it often does, since the length and strength of the expansion is still unclear, particularly for the U.S. The more drawn out the recovery becomes, the more likely short term rates will stay at historically low levels, adding support to the longer term bond market. Also, inflationary levels remain low, and are unlikely to rise soon as unemployment rates in the U.S. continue to rise into next year. High inflation has traditionally been the main enemy of the bond market, but this possibility seems remote as consumers struggle to regain their footing and developing countries continue to produce relatively cheap goods for export.
Nevertheless, the probability of significant future price appreciation for bonds is expected to be limited, if only due to the fact that yields are so low to begin with. However, with the world’s central banks expected to hold the line on their administered rates due to the still fragile economy, we continue to maintain the duration of the portfolio above that of the market indices in order to collect the higher yields available out the curve. Aggressive cuts in the over night discount rate contributed to the Fund’s positive performance, over the past year. This was also a breeding ground for many trading opportunities.