Should you invest in fixed income?
Investment Association statistics illustrate the point with the data revealing they were the worst-selling area for the second consecutive month in June with a net retail outflow of £198 million - the largest outflow since January 2014 when net retail sales were £298 million.
Overall, around £6 billion has been withdrawn from fixed-income funds over the course of 2015, and this has largely been down to investor concerns, according to Ant Gillham, manager of the Old Mutual Voyager Strategic Bond fund.
"Investors have enjoyed uniformly good returns from fixed income since the financial crisis but, unusually, the first half of 2015 has seen both government bonds and credit perform poorly," he explains. "Investors are used to having either credit or government bonds performing well at any one time but this hasn't been the case."
Patrick Connolly, a certified financial planner at Chase de Vere, believes many investors are also worried that fixed interest is overpriced and could be badly hit should interest rates start to rise. As a result, they have been considering other options.
"Instead of using fixed interest to provide protection portfolios, they're looking at cash, absolute return funds and alternatives," he says. "However, fixed-interest investments, such as gilts and corporate bonds, should have a place in most investment portfolios."
Generally seen as lower-risk than shares, although this will depend on the nature of the investment being made, a bond is an IOU whereby the issuer promises to pay back your capital at an agreed date, as well as a set amount of income every year until repayment.
Connolly suggests they are particularly suited to more cautious investors, including people near or in retirement, as well as those who have significant investment portfolios and want to enjoy some protection against stock market falls.
"These people often want to take less risk with their investments, perhaps because they are relying on this money to provide them with an income, or because they aren't able to earn extra money to compensate for any investment losses," he adds.
For fixed-income investors there are seven Investment Association sectors to consider: UK Index Linked Gilts; UK Gilts, Global Bonds, Sterling Strategic Bond; Sterling High Yield; Sterling Corporate Bond; and Global Emerging Markets Bond.
Within these sectors there is a very wide range of fixed-interest investment funds, many of which adopt different approaches. This means they can vary considerably in terms of the amount of freedom given to the manager, assets owned, where they invest geographically, the number of holdings, and the term remaining of individual holdings (duration).
It is important to remember that while investors want to achieve the best possible return, fixed interest is usually held to provide protection and diversification alongside growth assets such as shares and property. So which part of this market is most attractive?
Is this the right sector for me?
Consider investing in this sector if...
- you want a one-stop-shop approach to fixed-income investing
- you want a fund that can switch between fixed-income areas
- you are looking to diversify your portfolio
It's quite a conundrum, acknowledges Ben Willis, head of research at Whitechurch Securities, who has a negative stance on government bonds, as yields remain historically narrow at a time when there are question marks over when interest rates will rise.
"We continue to largely avoid conventional government and high-quality bonds, where we see little medium-term value and potential for capital losses," he says. "Our bond exposure will continue to focus on corporate debt."
Diane Weitz, a director and financial planner at Ashlea Financial Planning, suggests taking a look at strategic bond funds, such as the PFS Twentyfour Dynamic Bond, as these products enjoy much greater freedom to switch between different types of credit, depending on the economic backdrop.
"I quite like these funds, as they have the opportunity to invest globally and in different elements of the bond market," she says.
Mark Dampier, head of research at Hargreaves Lansdown, agrees they are worth considering but warns against being overly optimistic about their prospects. Investors, he suggests, must closely examine portfolios to ensure they understand the aims and objectives.
"These funds make sense because they have plenty of ammunition to help if things go badly wrong but their performance will always still depend on the fund managers and they don't always make the right decisions," he says.
How much exposure you want to fixed income will also depend on your economic outlook for the coming year and what you expect to happen to interest rates, as movements can have a dramatic impact on bonds.
It's a point echoed by David Coombs, head of multi-asset investments at Rathbones. "If rates rise faster than expected, then returns could be hit very hard, particularly in high yield where liquidity risk is underestimated."
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.