Fund Objective

The Standard Life Investments UK Gilt Fund aims to provide income by investing in mainly UK Government securities.

View on Past Performance

Corporate bond markets remain nervous as investors try to gauge the likelihood of further sub-prime losses and money markets remain dislocated. The emergence of possible downgrades to bond insurance companies has raised the spectre of forced selling within bond markets.Looking further out, the market remains concerned about the potential for an economic slowdown in the US that might cause an increase in default rates, although we do not think this will be as bad as some are predicting. In this environment, AAA-rated bonds should remain in demand, and indexlinked bonds are also looking more attractive. We have structured the Fund slightly long of duration, with a preference for medium-dated bonds.The UK Gilt Fund returned 0.08% over the month, compared to its IMA sector average return of 0.33%. Fund performance benefited from falling interest rates across the board. In particular our holdings in 10-year dated gilts boosted returns into the middle of the month as pension fund investors increased exposure to fixed interest securities at the expense of equities.Our decision to switch exposure out of 5-year gilts into German bunds also helped as expectations of a raft of interest rate cuts in the UK began to wane.During the month we took profits in the overweight position in 10-year dated gilts after a strong run of performance. We reduced our exposure to 5-year UK gilts, using the proceeds from this sale to initiate a new position in 5- year German bunds.

Future Expectations

With the markets now fully pricing in an extended rate cutting cycle, gilts appear fully valued. The is especially true given that the Bank of England's Monetary Policy Committee does not believe that the economy is operating with much spare capacity and is concerned at the risks of a pickup in short term inflation becoming ingrained in inflation expectations.This means the market's expectations of fastpaced rate cuts are likely to be disappointed. However, we are still cautious as the negative US economy will continue to support government bond markets. With the UK fully valued, our strategy as at the end of January was to favour European bonds in anticipation of the beginning of a rate cutting cycle by the European Central Bank.

Fund Details