Understanding strategic bond performance

At the other extreme, Mr Meghji, head of UK fixed income at Santander Asset Management and fund manager of the Santander Strategic Bond fund, says fund managers can invest in short-dated, cash-like instruments when value in fixed income markets look stretched.

Although this flexibility is a key potential benefit and are a key driver of absolute return strategies in the sector, Mr Meghji says it can also be a potential downside as the possibility to add value through a ‘go anywhere’ approach also brings the possibility that decisions may be riskier and might detract from value.

Gill Hutchison, head of investment research at City Financial, says speaking generally strategic bond funds tend to benefit from credit-friendly market conditions, as the majority of funds are biased towards credit and higher-yielding bonds.

Strategic bond fund managers typically deploy active ‘duration’ strategies and therefore Ms Hutchison says they have the potential to mitigate losses that would result from a rising interest rate environment.

Duration is a reflection of how long it will take to recover the initial investment value from coupons paid under the terms of the bond.

When interest rates are predicted to rise a shorter duration position will be adopted to avoid rate rises eating away at yield, but longer duration investments which have inherently higher yields will be held when rates are likely to remain low.

Ms Hutchison says: “Investors are often under the illusion, not unfairly given the naming convention, that strategic bond fund managers move portfolios around dynamically as market conditions shift.

“Market liquidity and the cost of trading mean that tactical positioning is often a challenge, especially for larger funds - although derivatives are helpful in this regard.

“The consequence of this is that funds are not always as able to step aside from trouble as investors might expect. The extreme conditions of 2008 demonstrated this in dramatic fashion.

“The reality is that the performances of strategic bond funds persistently reflect the biases associated with fund mandates and fund managers’ proclivities.”

Having flexibility is crucial because Stuart Rumble, investment director for fixed income at Fidelity Worldwide Investment, says different bonds perform better at different times of the economic cycle.

For example, Mr Rumble says when the economic outlook is poor, gilts tend to perform well. He says this is because government bonds are regarded as very secure.

Mr Rumble says: “Investors tend to move their money to ‘safe havens’ in troubled times. When the economic picture is brighter, corporate bonds – and particularly those regarded as high yield – are likely to perform well.

“Knowing which blend of bonds to invest in at any given time though takes skill and judgment so it makes sense to leave these difficult decisions to fixed income specialists.”

Carl Lamb, managing director at Almary Green, says ultimately different ways depending on the investment style – hence the importance of in depth adviser research.