Fixed IncomeFeb 23 2015

Bond funds with a flexible new twist

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According to the Investment Association, the Strategic Bond sector defines these types of funds as having at least 80 per cent invested in sterling-denominated fixed interest securities, with the ability to asset-allocate more of the portfolio to one of the fixed income securities at any point, whether that’s investment grade bonds or corporate bonds.

Chris Higham, manager of the Aviva Investors Strategic Bond fund, notes that investors are drawn to fixed income as a source of income and capital protection but that they have a hugely diverse asset class at their disposal, given the variety of issuers globally.

He adds: “From the relative safety of government bonds to more adventurous high yield and emerging market bonds, the complex landscape can sometimes prove difficult to navigate. Throw in an ever-changing macroeconomic environment that means no one type of bond outperforms in all market conditions and investors may struggle to stay on top of their asset allocation choices.”

This is where strategic bond funds come in, according to Mr Higham: “The manager of a strategic bond fund can look at the wider macroeconomic environment and strategically tilt the portfolio to those securities that they think will generate attractive returns. They can invest strategically across asset classes and geographically across the fixed income spectrum.”

Stewart Cowley, investment director, fixed income and macro at Old Mutual Global Investors, acknowledges that there is some confusion around this asset class. He explains that there are a couple of groups of strategic bond funds available to investors.

“The strategic bonds sector is basically managers who move between investment grade and high yield in different proportions and they call themselves strategic bonds,” he says. “So they will perform roughly plus or minus in line with the market, depending on the skill of the underlying manager or the index they are being managed to.”

The other group of strategic bond funds are what he refers to as the “go-anywhere guys”: “A sort of go anywhere, total return type of approach, coming at it from a macro perspective. They may or may not be attached to a specific index,” he adds.

Essentially, these types of strategic bond have the ability to go long or short the markets and can have weightings in currencies as well.

“So it’s a kind of mishmash of the lost and the lonely,” Mr Cowley admits. “Investors find it very difficult to find their way through the sector and usually choose on the basis of the reputation of the manager or how the behavioural characteristics of the fund fit into what they’re trying to do.”

When choosing a strategic bond fund for a portfolio, “firstly [you need] to establish what your universe of strategic bonds are – [that] is probably quite important,” says Adrian Hull, senior fixed income product specialist at Kames Capital. “I just encourage people to have a top-down approach and look at currency, look at equity, convertibles. What you’ll tend to see is more volatile funds have more volatile assets in them.”

These types of funds are popular too, according to Mr Hull – a view backed up by Investment Association figures that show its Strategic Bond sector was the bestselling sector by net retail sales in 2012. The sector also clocked up 12 consecutive months of inflows in net retail sales in 2014, peaking at £278m in July.

In spite of its apparent popularity, needless to say the strategic bond fund will not be suited to all investors.

Mr Cowley says they are generally accessed in the UK by wealth managers, fund of funds and life companies, as well as high net worth individuals. He also notes that investors in strategic bond funds should consider why they are investing and suggests that they tend to fit well in an overall balanced portfolio.

Ariel Bezalel, manager of the Jupiter Strategic Bond fund, adds: “Bond funds may play an important role in the construction of a well-balanced portfolio, helping to provide diversification and smooth returns over the long term.

“Bond funds which take a global approach and have full freedom in making sector allocations and steering duration are more likely to be able to anticipate changing market trends and take advantage of opportunities.”

Ellie Duncan is deputy features editor at Investment Adviser

ADVISER VIEWS

Jonothan McColgan, director and chartered financial planner, Combined Financial Strategies

“Mark Carney’s proposed 2 per cent interest rate rise has only been delayed by the current dip in inflation caused by the temporary downturn in oil prices. So a 2 per cent rise in interest rates could knock over £4.4bn off the value of the 10 largest bond funds, creating a fall in value of about 9 per cent.

“However, with a pending election and uncertainty in global economic growth, you could also be wary of investing in high yield bonds where they are better equipped to cope with rising interest rates but much more volatile as an asset class.

“The strategic bond sector provides funds that have much more investment flexibility than other bond funds that are invested either in sterling corporate bond or sterling high yield. We believe that those funds that generate a reasonable level of yield (to offset any future capital losses) and that have the flexibility to change their investment bias offer greater protection in these times.”

Patrick Connolly, certified financial planner, Chase de Vere Independent Financial Advisers

“Most investors should hold fixed interest to provide diversification and a degree of protection alongside equities. However, the conventional wisdom of fixed interest being low risk doesn’t necessarily work today. As a direct result of the actions of central banks, prices on many fixed interest assets are at artificially high levels. In this environment, we believe the best way to get exposure to fixed interest is through strategic bond funds. We aim to invest with managers who have the flexibility to have the best chance of hopefully finding pockets of value while avoiding the most expensive and vulnerable assets.”

Jaskarn Pawar, chartered financial planner, Investor Profile

“I would say any bond fund is a strategic bond fund of sorts – whether that strategy remains the same from the outset, like a passive fund, or the strategy is adjusted along the way, as in an active fund. From that point of view, it is important to hold strategic bond funds within any well-rounded, well-diversified portfolio. Most importantly, bond funds can be used to dampen volatility and increase the accessibility of a portfolio, which is useful in any financial planning strategy. Because the fixed interest portion of an investor’s portfolio is likely to make up a significant part of the overall piece, it is likely that an adviser would choose more than one fund. This again is useful, because you can use that requirement to diversify the portfolio of bond funds.”

STERLING STRATEGIC BONDS: SECTOR DEFINITION

The Investment Association’s definition of the Sterling Strategic Bond sector is: “Funds which 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.

“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.”