Fund briefing: strategic bonds
Bonds are essentially loans to governments or companies and they are also known as ‘fixed income’, because they repay a fixed level of interest to investors over a set period.
There are lots of different types of bond funds, each giving exposure to different types of bonds:
- Government bonds are loans to governments (also called ‘gilts’).
- Investment-grade corporate bonds are loans to big companies that have good credit scores, which means they are more likely to repay the debt.
- High yield bonds are loans to companies that have lower credit scores, which means that they might be more likely to default on the loan and not pay it back.
If you want diversified exposure to fixed income, consider a fund from the Investment Association’s Strategic Bond sector. These funds are able to invest in a wide variety of government, investment- grade corporate and high yield bonds.
This makes them the ideal one- stop shop for anyone who feels more comfortable letting professional fund managers decide which parts of the market have the best chance of delivering decent returns.
Back when the sector launched in September 2008, following a review of how fixed income funds were classified, there was less than £12 billion invested.Today, the figure is close to £30 billion, according to the Investment Association.
Given the volatile and uncertain economic, political and stock market outlook, which makes it more difficult for investors to know where to invest, it’s unsurprising that strategic bond funds have grown in popularity over the years.
Andrew Merricks, head of investments at Skerritts Consultants, says that funds in this sector are suitable for anyone looking to draw an income from a bond portfolio, as long as they are not held back by unrealistic constraints.
“A good strategic bond manager will allocate between the different bond types and, hopefully, should have freedom to allocate without being restricted by having to invest, say, 40% of his assets in gilts,” he says.
This is a key point. Funds can vary considerably in terms of the amount of freedom given to the manager, the types of assets they invest in, the number of bonds they contain, and the term remaining of individual bond holdings (known as the duration).
IA Strategic Bond, which contains more than 80 funds, is home to funds investing at least 80% of assets in Sterling denominated (or hedged back to Sterling – which means they remove any overseas currency risk) fixed interest securities. Funds in this sector can also include convertibles (bonds that can be changed into equity) and preference shares (a share that entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends), but not all do.
Depending on the economic backdrop, the fund manager may opt for traditional government bonds at one stage, and riskier high yield bonds that behave more like shares at another stage. However, not all strategic bond funds use the flexibility available.
Some strategic bond managers will stick pretty rigidly to traditional sources of income, such as investment-grade corporate bonds, while others will be looking to embrace more esoteric areas of the market, such as convertibles and preference shares.
Investors need to judge the performance achieved on the way the portfolio has been run. A look at the performance figures illustrates the point.
Over the five years to 19 April 2016, the average fund in the IA Strategic Bond sector returned 25.8%, according to Morningstar figures. This is more than the IA High Yield sector (21.9%) and slightly less than the IA Corporate Bond sector (29.6%).
However, there is a marked difference between the performances of individual funds within the Strategic Bond sector. While the best are up 60%, the worst have made less than 10% gains.
Just because they come under the same umbrella sector doesn’t mean their performances will be the same, so each one must be judged on their own merits, explains Mark Dampier, research director at Hargreaves Lansdown. “Some will focus more on income generation; others will be more concerned with capital growth, or sheltering capital,” he explains. “Investors need to be sure a fund is suitable for their circumstances before investing.”
Too much choice is not always a positive because there’s always the danger of a manager making the wrong decision – and one that ends up leading to significant underperformance. After all, strategic bond funds may have the potential to perform well regardless of which part of fixed interest is doing the best, but it all comes down to the manager’s ability to spot and take advantage of any opportunities that arise.
Justin Modray, founder of Candid Financial Advice, believes strategic bond funds are just another tool for investors to consider and not the answer to everyone’s prayers.
While he accepts that strategic bond funds provide the manager with the flexibility to weather any storms, he insists that whether they are suitable will depend on an individual’s needs.
“If bond markets do tumble, then a strategic bond manager is likely to suffer along with the rest, albeit hopefully not to the same degree as a plain vanilla corporate bond fund,” he says.
Fund to watch:
Artemis Strategic Bond
Managed by James Foster and Alex Ralph since its launch 11 years ago, the Artemis Strategic Bond fund aims to achieve a combination of income and capital growth by investing in fixed income markets.
It embraces fixed interest securities issued by governments, companies and other entities, all of which pay an agreed level of income or interest. In addition, it may invest in higher-yielding bonds, which may increase the risk to an investor’s capital.
Bonds come in different risk grades with AAA the highest and C the lowest. This fund has 35% of assets in bonds with a credit rating of BBB, with 25% in BB and 19% in B, according to the latest fund fact sheet. As far as sectors are concerned, it has the highest weighting in financials (36%) and utilities (13%).
“We were busy in February as distressed selling gave us great opportunities to invest,” wrote the managers. “We have been buying across the board but particularly insurance companies such as Aviva and Swiss Re.”
It’s a fund favoured by Mark Dampier, research director at Hargreaves Lansdown, who says it has an experienced management team with the freedom to exploit opportunities across the fixed income spectrum.
“We believe the fund could appeal to investors seeking a combination of capital growth and income from the fixed income market, although it tends to carry higher risk than the average fund in the sector,” he says.
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.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
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.