The latest monthly Investment Association report revealed that UK investors continue piling into fixed income funds, despite concerns that bond markets may be vulnerable as central banks shift towards normalising monetary policy.
According to the survey, fixed Income was the best-selling asset class in June, with net retail sales of £1 billion.
Bond markets have performed strongly since the financial crisis, mainly boosted by government and central bank policies, such as low interest rates and quantitative easing. While bonds have provided investors with strong capital gains, bond yields have been pushed to historic lows, making them unattractive for income investors.
However, as we move into an environment where the US Federal Reserve has started to raise rates in response to rising inflation expectations, investors are concerned that this could cause bond prices to fall and yields to rise.Therefore, now more than ever, investors need to look beyond traditional ‘safe’ bonds and adopt a more flexible approach to address rising interest rates and inflation concerns.
Different bonds react differently to rising interest rates. For example, a 1 per cent rise in yields will have a much larger impact on the price of longer-maturity government bonds compared to shorter-maturity bonds. This means short duration exposure to bonds could help investors reduce the impact of rising interest rates and market volatility.
Furthermore, investment grade, high-yield and emerging market bonds are considered to be less sensitive to interest rates than government bonds, so their price return is better in a rising rate environment. They usually have higher yields and their total return is also better.
Bonds continue to offer investors the benefits of diversification away from equities, along with stable income and relatively low volatility. However, given the low yield environment, investors must make their bond funds work a bit harder than they have done in the past.
Global and Strategic bond funds may be best positioned to navigate the current environment. These funds have the flexibility to seek the best returns from across global markets and to move their asset allocation significantly, shifting exposure to government bonds, investment grade corporate bonds and high-yield bonds depending on the prevailing environment.
Money Observer Rated Funds
M&G Global Macro Bond fund invests across a broad range of fixed income securities around the world, including bonds issued by governments and companies in developed nations and emerging markets. The ability to invest anywhere and in any currency gives the fund the freedom to select those assets the fund manager, Jim Leaviss, believes are likely to benefit from the prevailing market trends and economic condition.
His current investment themes include a significantly underweight duration stance, caution towards areas of the credit market, and a more constructive view on the outlook for the euro.
Marlborough Global Bond fund is managed by highly experienced co-managers, Geoff Hitchin and Nicholas Cooling. They employ a relatively cautious approach, designed to capture upside while limiting effects of market falls by investing in government and corporate bonds around the world.The portfolio includes more than 400 bonds diversified by geography, credit rating and duration. Currently, the fund is heavily weighted to UK and US bonds with sterling and the dollar were also the main currency exposures.
Jupiter Strategic Bond is a global fund that can invest in many different parts of the bond market in search of what the manager believes are the most attractive investment opportunities. Managed by Ariel Bezalel, the fund has the flexibility invests in high yield, investment grade and convertible bonds in addition to preference shares and derivatives.
The fund manager is currently cautious in his outlook for developed markets, especially for the US, but he is still finding attractive opportunities, in particular in bonds issued by European banks and in emerging markets. India continues to be his top pick. Given the uncertainty around interest rates, he prefers shorter duration strategies to reduce risk.
Baillie Gifford Corporate Bond is a strategic bond fund that invests in a diverse portfolio of investment grade and high yield sterling denominated bonds in order to generate a high level of monthly income whilst preserving capital.
The managers, Stephen Rodger and Torcail Stewart, buy bonds issued by companies worldwide which they believe are resilient, with stable or improving financial characteristics that can deliver an attractive return for investors.
They think that the current macroeconomic backdrop remains ‘colourful’: interest rate hikes in the US and Brexit negotiations in the UK and keystone elections in Europe. As ever, such turbulence can throw up valuation opportunities.
Their most recent new bond ideas for the portfolio have a more European orientation. More than 20 per cent of the portfolio is in the bonds of insurance companies, with close to 20 per cent in the debt of technology, media and telecoms companies.
Keep up to date with all the latest personal finance news and investment tips by signing up to our newsletter. Email subscribers will also receive a free print copy of Money Observer magazine.
This article was originally published on our sister website Interactive Investor.