Dollar fund chief Ben Yuen remains cautious about a fast economic recovery in America, but believes bonds are attractive at this point in the interest rate cycle Ben Yuen, head of fixed income, Asia, for First State Investments, watches the US treasury market very closely. Any major movement in the market makes an impact on his funds' prospects, particularly First State's Asian US dollar bond fund and Hong Kong dollar bond fund. Both funds are for institutional investors, but US treasury movements also affect the bond holdings in First State retail funds. 'For both funds, the movement in US treasuries is quite significant,' Mr Yuen said. 'It is crucial for the Asian US dollar bond fund performance, and also crucial for the Hong Kong dollar fund because of the dollar peg.' In the past few months, yields on 10-year government bonds have increased dramatically, from a recent low of 3.07 per cent to 4.6 per cent on September 3. A major reason for the rise in US treasury rates, which is accompanied by a corresponding fall in capital values, is a perceived shift in policy by Federal Reserve chief Alan Greenspan away from 'unconventional' support for long bond prices. Another is an expectation that with the recovery of US corporate earnings, pressure will grow for interest-rate adjustments to cool an overheated economy. Mr Yuen said there was also a significant technical factor behind the sharp rise in US treasury rates: hedging by managers of US mortgage-backed securities portfolios. These managers find the average duration (time to maturity) of their holdings increases when yields rise, and they sell US treasuries as an off-set. Mr Yuen said First State, part of the Commonwealth Bank of Australia group, was not as optimistic as some about the strength of the US recovery, and thus the future trend in interest rates. While earnings reports are coming in above analysts' expectations, corporate and individual debt has in many cases been restructured rather than paid off. 'Looking at market performance, people are pricing in a fast US recovery,' he said. 'But the question is whether people are too optimistic. Corporate and individual gearing ratios in the US are still at historic highs.' At the individual level, Mr Yuen noted that home buyers had been refinancing their mortgages to cash in a portion of the rising value of their homes. The recent rate surge would tend to discourage refinancing, and was therefore negative for consumption as people would have less to spend. Bond investors suffer capital losses when interest rates rise, but as they are typically long-term investors, many will retain the bonds in their portfolios come what may. A typical bond investor will hold bonds through several investment cycles. 'Corporate investment portfolios and insurance companies have to include bonds in their portfolio, no matter where the interest-rate cycle is,' he said. Mr Yuen points out that coupon payments insulate bond holders from some of the downside in a rising interest-rate environment. In any case, we are not at this point yet, in his opinion: 'We still don't think interest rates are at a turning point. We don't believe investing in the bond markets at the moment is dangerous. We believe short-term interest rates will remain at a low level. And there is scope for the yields of long bonds to move down. The absolute yields on long bonds are quite attractive.' First State's Asian US dollar portfolio contains a mix of Asian corporate securities and government debt. Mr Yuen said many Asian companies had become attractive as bond issuers. In today's investment environment, an absolute return of about 5 per cent per annum was reasonable for an investor in a bond portfolio. First State funds have achieved higher returns over the past few years. The US dollar-denominated First State Asian Bond Portfolio returned 11.2 per cent over the year to July 31, 29.3 per cent over two years and 49.3 per cent over three years. The CMG Fixed Income Fund with Guarantee, broadly similar to the institutional Hong Kong dollar bond fund, returned 3.8 per cent over the one year, 10.5 per cent over two years and 14.5 per cent over three years. PROFILE 1992: BSc with first class honours in management science from the University of Wales 1993: MSc in finance from Lancaster University 1994: Joined HSBC Asset Management 1999: Promoted to senior investment manager 2000: Joined First State Investments 2001: Appointed head of fixed income Asia