Consistent outperformance through the use of a “value-orientated but opportunistic approach” has seen the £915m Royal London Sterling Extra Yield Bond fund catapulted into the Investment Adviser 100 Club in 2013.
Manager Eric Holt says the aim of the fund is to provide a high level of income to clients – currently the fund has an income yield of roughly 6 per cent – from which the charges are taken, so “you’re not diminishing capital for the sake of generating income”.
He adds: “In the context of market conditions and opportunity markets, we think that’s an attractive yield level, and we think that corporate bonds are relatively good value.”
The manager says the fund is different from other high yield vehicles, sitting in the IMA Strategic Bond sector rather than IMA Sterling High Yield one mainly because of the orientation of the fund.
“We invest across investment grade, sub-investment grade and unrated bonds. We don’t have enough in high yield, in spite of the yield orientation of the fund, to be classed as a high yield fund. It also wouldn’t really reflect the investment orientation.
“We run a diversified portfolio – to manage the upside-downside risk that is particular to bonds well – and focus on opportunity and income, as income generation is really important in the current economic conditions.”
He adds the fund can invest in a wide range of opportunities, and describes it as “a very value-orientated but opportunistic approach”, and notes that being in the strategic bond sector makes it a “bit different”.
For the five years to May 8 the Royal London vehicle has significantly outperformed the sector average, delivering a return of 150.49 per cent compared with the IMA Strategic Bond sector average of 61.56 per cent.
The shorter-term performance is equally impressive, however, with a 12-month return of 9.08 per cent against the sector average of 2.5 per cent, according to FE Analytics.
While the overall positioning of the fund has remained the same since launch in 2003, Mr Holt notes the nature of the opportunities has probably changed over the years.
He explains: “We invest across the three sectors of investment grade, sub-investment grade and unrated. The weightings within those three sectors don’t really change very much from quarter to quarter. We are not, as such, targeting weightings in different sectors, it is more a comment on the opportunities that come up. In many ways it is robust to have investment across that spectrum because if conditions change in one sector there might be opportunities in another.”
He says the performance in the past year is pleasing, against a background where “gilts had pretty much the worst year for 20 years”. Mr Holt explains some of the factors underpinning the strong returns include having a strong yield on the fund, and the flexibility of being able to look for opportunities across the market.
Examples include the “slightly quirky” 100-year sterling bond from EDF Energy earlier this year, which had approximately a 6 per cent yield and which has since performed well, along with investments in Nationwide Building Society in Core Capital Deferred Shares (CCDS).
The manager says: “The portfolio sits within the framework of our macroeconomic view, but it is very much stockpicking and stock selection that’s intrinsic in the way we manage our portfolio.
“If we were very bearish on the economic outlook then the financial sector would not be one where we would feel as comfortable. If we thought inflation was going to become an issue in the medium term we’d probably be more reticent about buying bonds with more duration on them. But we think the background is reasonably conducive to bond investors.”
Juliet Schooling Latter, research director, Chelsea Financial Services
Verdict
As the name suggests, this fund aims to produce a high income, and it hasn’t disappointed. It is currently yielding almost 6 per cent, but as with all things, this higher yield does come with higher risk. The fund has a high weighting to high yield bonds, as you would expect, and the manager also likes to invest a significant amount in unrated bonds – those where a company hasn’t paid a ratings agency to rate them – as he likes to do his own research. He has been very successful at doing this, though, and the fund has a lot of merit for income investors willing to take the extra risk.
