Absolute return bond funds are seeing a surge in popularity from retail investors as concerns mount about potential losses from traditional fixed income funds.
Most experts believe that the US will begin to raise its interest rates within the next few years, with the UK likely to follow suit, which will mean bond yields are likely to rise.
A rise in yields corresponds to a fall in the value of the bonds, meaning investors in conventional bond funds are likely to lose money.
In response to these anticipated losses, absolute return bond funds, which can use derivatives and other instruments to make money when the markets fall, have seen a pick-up in inflows in the past year.
The £213.1m Swip Absolute Return Bond fund, run by James Carver, has more than doubled in size in the past year, driven by the fund’s consistently positive return profile since the beginning of 2009.
Mr Carver said the prevalence of low bond yields had made long-only bond products a high risk, low reward investment and had led to more interest in absolute return bonds.
He said the past year had seen a change from having to go out and explain the rationale behind absolute return bonds to potential investors to now receiving regular calls from interested buyers.
He said: “The flows are not just out of other fixed income products. Some people are trying to de-risk from equities, but do not want go into conventional bonds and lose money.”
The top-selling absolute return bond fund has been the Ignis Absolute Return Government Bond fund, which has already reached £1.5bn in assets in spite of only being launched in 2011.
However, the Sicav fund has seen the majority of its sales coming from continental Europe and is mainly seeing interest from more sophisticated investors.
The demand for absolute return bond funds from institutional and sophisticated investors is far more established than among retail investors, where the concept of absolute return is still not viewed positively by a significant proportion of advisers and investors.
Mark Holman, chief executive of fixed income boutique TwentyFour Asset Management, said the firm was looking into launching an absolute return bond fund in 2014, but only for institutional investors because he thought there was far more demand for such a fund there than in the retail space.
However, the retail inflows into the Swip fund – as well as Ian Winship’s £88.2m BlackRock Absolute Return Bond fund – in the past year show that investors are being increasingly converted.
Mr Winship said that for too long there had been a lot of simple homogenous products in fixed income and investors were just beginning to realise they needed to have access to funds that acknowledge the fixed income market would not always go up.
He said: “Interest rates will go up, although probably not by much more in the short term, but we are trying to prepare for that future.”
When an asset class becomes popular, money tends to become concentrated towards the larger and more established funds. However, the biggest UK-based fund – the £345.5m Threadneedle Absolute Return Bond fund, run by Matthew Cobon – has seen money flow out in the past year.
This is because it has failed to deliver any return at all for more than three years.
The changing shape of bond funds
Strategic bond funds
Absolute return bond funds are not the only products to see increased interest due to the probability of losses on traditional bond investments.
Strategic bond funds have been even more popular, although for the same reason in that they generally have a flexible remit that allows them to invest across the fixed income spectrum and even use instruments such as derivatives to produce returns. Richard Woolnough’s M&G Optimal Income fund, a member of the Investment Adviser 100 Club of top-performing funds, has grown to be one of the biggest funds in the IMA universe at £15.7bn.
Asset-backed securities
These are fixed income products that comprise of debt borrowed against a particular asset, for instance mortgage-backed securities, which are bonds borrowed against a collection of mortgages.
The attraction of asset-backed securities in the current environment is that the bonds are “floating rate”, so investors will not lose money if interest rates rise. Kames’s Phil Milburn said the asset class was his favourite investment in his Strategic Bond fund. There are not many pure ABS products for retail investors as the market is quite illiquid. There is still some stigma attached as risky asset-backed securities were in part to blame for the collapse of the US housing market, which lead to the 2008 financial crisis.
Loans
There have been a number of products, mostly investment trusts due to liquidity issues, launched in recent years investing in the more niche areas of fixed income and the loans market has attracted a lot of attention.
The £821m NB Global Floating Rate Income investment trust has attracted much interest since it was launched in 2011, and is in the process of raising another £200m in a C share issue. The trust invests in “below investment grade senior secured corporate loans” which provide protection against rising interest rates while still paying a decent yield. JPMorgan Asset Management recently moved into the space by announcing it would launch a trust investing in US senior secured loans for Jim Shanahan.
.
