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It would be an understatement to say markets have been volatile. As equity markets continue to decline, the fallout from the credit crunch has presented interesting opportunities in the bond markets. Corporate bond spreads are at extremely high levels making them attractive in terms of both yield and capital growth prospects.

Corporate bonds, however, are not as safe as houses and they too have been under scrutiny, particularly in the financial sector. In this environment it is therefore important to identify fund managers that can deliver consistent returns in all market conditions rather than aiming for stellar performance at any cost.

Richard Hodges who runs the Legal & General Dynamic Bond Trust could be one such manager. He joined L&G in February 2007 after 17 years at Gartmore. His experience is in the fixed income market, but interestingly he has a great deal of derivatives experience. This is something that is becoming widely accepted in the retail world as investors learn to appreciate that derivatives can have many uses.

The fund is essentially a strategic bond fund with a derivatives overlay. As it has the full Ucits III powers it can utilise these tools using credit default swaps and OTC instruments.

There are two main reasons for using derivatives. First, it allows Mr Hodges to manage the portfolio more efficiently. For example, if he believes the yield curve will steepen he can make use of a swap much faster and more cheaply than by increasing the bond exposure in one part of the curve and reducing it elsewhere. Second, he uses these tools as a way to manage the risk in the portfolio, something he believes can be a source of value generation. The derivatives element is therefore also used to offer some protection on the downside.

This is an unconstrained fund with a total return approach. It looks to add alpha from anywhere in the bond market which means it does not target a specific yield. In general, the fund’s neutral position is 50 per cent in investment grade and 50 per cent in high yield bonds. If Mr Hodges is bullish on the market the fund is likely to be overweight high yield bonds and vice versa. If he expects financial Armageddon, then the portfolio can hold up to 100 per cent in cash. Overall, he is looking to achieve top quartile returns relative to the IMA UK Other Bond sector and outperform the iBoxx Sterling Non Gilt index by 3 per cent (before fees) over a three to five-year cycle.

There are three main areas from which alpha is likely to be generated. The first is asset allocation. Not all fund managers place importance on asset allocation, but this can be a huge source of value. Mr Hodges therefore looks at which bond markets are the most attractive on a risk adjusted basis, ranging from government bonds, investment grade and high yield bonds.

The second area of alpha generation is directionality. This basically involves assessing the level and slope of the yield curve depending on the asset allocation view. This would have been an important decision in 2007 when interest rates were on the decline.

The third area is relative value. This is more stock specific assessing where the value is in individual bonds and determining whether any exposure to the portfolio should be held on a long, short or paired (long/short) basis. Interest rate movements and credit analysis are therefore crucial, as is the ability to move around swiftly between the different assets in order to generate the best possible risk-adjusted return for investors.

There is more to this fund than meets the eye. It was made available to the retail market in March 2008 and it could offer investors a route into an investment that could deliver solid long-term returns while keeping risk at bay.