Standard Life stays safe with government bonds

LONDON (Reuters) - While markets display jumps and plunges on the crest of the credit crunch wave, one of Britain's more cautious investors is holding firmly onto the bonds life raft and sees more value in government debt to come.

Government debt markets retreated on Monday as more governments took concrete action to bolster the banking system, helping global shares rally and dampening flight to quality flows.

Equities .FTEU3 and bond prices dropped over the course of last week, but unperturbed Andrew Milligan, head of global strategy at Edinburgh-based Standard Life Investments with 130.6 billion pounds-worth of assets under management, said he was sticking with fixed-income.

"We are not selling government bonds at the moment," Milligan told Reuters in an interview.

He said that while bonds have rallied sharply in recent weeks, Standard Life's economic, inflation and interest rates outlook was still below consensus.

"We are going to be seeing very sharp short rate cuts during the course of the coming year so we are happy to hold a heavy position in international government bonds in our portfolios."

Milligan favors German debt, the euro zone's benchmark and most liquid government bonds, because he sees more scope for rate cuts by the European Central Bank, which have lagged the U.S. Federal Reserve and the Bank of England.

But with Greek 10-year government bond yields topping 100 basis points over Bunds last week - the first time a euro zone sovereign's spread has moved into three digits - it is only a matter of time before peripheral debt becomes attractive again.

"(With spreads) at record highs since the euro was formed then from my point of view, a priori that would be very interesting indeed to look into and to start thinking of buying," he said.

Last week, it wasn't only equities which suffered from banking sector woes, bonds too dropped sharply as investors fretted over likely increased debt supply from government efforts to cure the credit crisis. Market participants say it will take a while for the various government measures to restore market equilibrium.

LESS RISK ALLURE TO STAY

"There will be a recession, even if no one actually likes the sort of restructuring that it brings," said Milligan.

"Holding bonds is therefore warranted."

Anecdotal evidence with private wealth bankers showed clients are putting cash into bonds with a very short maturity until they come due, he said.

"They know that they'll only get a percent in terms of income but in terms of sleeping at night they are happy," he said.

Standard Life Investments' funds have shrunk to 130.6 billion pounds as of June this year from 143.4 billion at the end of 2007, which Milligan attributes to falls in financial markets at a time the fund manager has been winning new business.

The funds are heavily weighted in favor of UK assets with 109 billion pounds, followed by Canada at 13.3 billion, then Ireland, Germany, India and other Asia. U.S. assets are mostly managed out of Canada and Boston, in the United States.

By asset class, that was 52.7 billion pounds invested in equities, down from 58.5 billion pounds at the end of 2007; 43.1 billion pounds in fixed income from 49.5 billion; 3.6 billion pounds in inflation-proof bonds versus 4.2 billion pounds and property at 12.0 billion pounds down from 13.8 billion pounds.

Conversely, the remainder held in cash, rose to 19.3 billion pounds from 17.4 billion.

At present, his fund managers are overweight relative to a balanced pension fund portfolio in corporate bonds, followed by international bonds, then defensive equities, neutral in cash, and underweight in cyclical equities and finally commercial property.

While markets brace for heavy extra debt issuance from governments to fund financial stability measures, Milligan said there would be areas in the bond yield curve that investors will find attractive.

"There are sizeable pockets of wealth out there that are looking to invest in cheap assets," he said.

Investors will be either lured to public sector debt when yields are attractive, resulting in a steeper yield curve, or central banks will keep short rates low while governments make longer rates attractively high, he said.

In the case of the United States, there will be "an appreciating dollar that will encourage overseas investors to buy U.S. assets, especially U.S. debt," said Milligan.

(Editing by Andy Bruce)