Strategic bond funds are usually a popular diversifier in UK investors’ portfolios. These funds have the ability to diversify across fixed interest securities and so are a useful way to be invested in the asset class.
But recent global market volatility appears to have knocked investors’ confidence in fixed income, and strategic bond funds are falling out of favour among investors.
In July this year the IA Sterling Strategic Bond sector was the worst selling Investment Association sector, recording a net retail outflow of £140m. In August, that outflow rose to £173m, although it was not the worst-selling sector during the month. Up until June, the sector had seen positive net retail sales since August 2014.
Steve Kenny, head of retail sales at Kames Capital, acknowledges: “The benefits, in simplistic terms, are the ability to access a diversified fixed income fund with the investments spread across the fixed income spectrum – it allows clients to outsource the decisions on how to manage their fixed income weightings within portfolios.”
The benefits remain the same, so what’s changed?
Mr Kenny suggests: “Fixed income as a whole is unloved at present, and I think this sector, given its popularity in recent years, has been subject to some top slicing by clients as they put monies to work in different areas or park cash.”
Figures will also have been affected by the sizeable outflows from the M&G Optimal Income fund.
But Eric Holt, manager of the Royal London Sterling Extra Yield Bond fund, believes performance is to blame for turning investors off strategic bond funds.
“Sterling corporate bond sector performance has been strong over the medium term, and strategic bond funds generally have added little to this,” he says.
“Their potential to be defensive by short duration positioning has passed slightly unnoticed in a phase where gilt yields have remained at historically low levels.”
FE Analytics would appear to corroborate this, with the Sterling Corporate Bond sector returning an average 2.6 per cent to investors in the past 12 months to October 1, compared with the 0.9 per cent average generated by the Sterling Strategic Bond sector.
Mr Kenny agrees: “They have been, as you would expect, mixed. The sector is fairly eclectic in composition, so anyone who is running long European high yield has done better than those who have been more conservatively weighted or biased to the US high yield market.”
He also thinks there is another reason for a lack of enthusiasm for these funds. “The ability to navigate profitably around duration and credit risk, especially in the volatile and thin market conditions prevailing in the recent past, would seem to be a challenging concept to promote.”
The environment for strategic bond investing is not likely to get any easier either.
Mr Holt forecasts: “As evidenced by recent volatility, market conditions and the global economic background both remain challenging. Consequently, interest rates seem likely to remain low and inflationary pressures subdued.”
As Mr Kenny points out, the “elephant in the room” is when the US Federal Reserve will finally confirm it will begin raising interest rates.
He observes that markets dislike uncertainty, so once the first rate hike is out of the way, he expects some of the negativity surrounding bonds to subside
It will be interesting to see whether any pick-up in sentiment translates into improved net retail sales for the strategic bond fund sector.
Ellie Duncan is deputy features at Investment Adviser
Sector definition
The Investment Association defines the Sterling Strategic Bond sector as funds that invest at least 80 per cent of their assets in sterling-denominated (or hedged back to sterling) fixed interest securities. This excludes convertibles, preference shares and permanent interest-bearing shares (PIBs).
At any point in time the asset allocation of these funds could theoretically place the fund in one of the other fixed interest sectors. The funds will remain in this sector on these occasions since it is the manager’s stated intention to retain the right to invest across the sterling fixed interest credit-risk spectrum.
