Strategic bonds outmaneuvered by UK gilts

But for the 12 months to February 13 2015 the best performing Investment Association bond sector was the IA UK Index-Linked Gilts sector with an average return of 16.46 per cent, followed by the IA UK Gilts sector return of 13.76 per cent.

In contrast, the IA Sterling Strategic Bond sector delivered just 6.58 per cent for the 12-month period. A closer look at the sector’s constituents shows the performance for the 12 months to February 13 range from a high of 26.33 per cent from the Axa Sterling Long Bond to a loss of 1.07 per cent for the Pimco GIS Diversified Income Duration, according to data from FE Analytics.

This variation can partly be attributed to the inherent flexibility that strategic bond funds can employ.

Eric Holt, manager of the Royal London Sterling Extra Yield Bond fund, explains: “There’s a wider range of approaches within the strategic sector than there is within the high-yield or corporate bond sectors.”

He adds that the flexibility around duration is probably greater within the strategic sector, and suggests this “has been the one thing that has been the primary differentiator of performance”.

The manager points to the unexpected returns of government and corporate bonds in 2014, at a time when some suspected interest rates and yields would normalise rather than shift down further.

“We have been in an extraordinary period of time. Given what occurred to corporate and government bond yields, it was quite hard for strategic bonds to match those returns, because having the right orientation to interest-rate duration – which was a key aspect to those returns – would have been quite challenging.”

Fraser Lundie, co-head of credit and senior credit portfolio manager at Hermes, agrees that strategic bond fund managers have a lot of flexibility, including actively managing their duration exposure.

He explains: “In theory, this ability would be particularly helpful in a context of rising interest rates since these funds would benefit from rate rises and, thus, deliver positive returns unlike more traditional fixed income funds. But it is very important to see what a fund’s duration is, and what the actual sources of that duration are.”

Overall, the outlook for the fixed income sector remains “challenging”, says Mr Holt.

He adds: “While economic growth in the past year has been good in the UK… in the context of the longer term, we’re still in a very long-haul recovery from the depths of recession.”

This is where strategic bond funds should shine, points out Mr Lundie, because of “their ability to invest on a global basis, and, in doing so, significantly improve available risk-adjusted returns. But it is vital to ascertain to what extent a strategic bond fund is truly global in its underlying investments in order to gauge its ability to diversify such risks in times of heightened volatility.”

Nyree Stewart is features editor at Investment Adviser

EXPERT VIEW

Chris Higham, manager of the Aviva Investors Strategic Bond fund, gives his outlook for the sector:

“One of the key questions on our minds is how far down the credit spectrum are investors likely to go in this low-yield environment, given the unprecedented efforts by central banks globally to ease monetary policy in order to support growth. Many assets are already in negative-yield territory and investor moves into lower-rated paper is evident in order to capture higher returns. There is a lot of uncertainty on the policy front and political risk in 2015 is a major theme that could destabilise markets.”