While strategic bonds are still considered a relatively new concept that some advisers and investors may not be entirely familiar with, they have found their place in many portfolios.
The latest Investment Association figures reveal that the Strategic Bond sector was the fourth best-selling sector in November last year, with £144m in net retail sales.
In a world where monetary policy tightening seems to be on the agenda in the US and eventually the UK, and where the central banks of Japan and Europe are rolling out quantitative easing, bonds may fall out of favour among investors as they rotate into equities.
The Fidelity Worldwide Investment outlook survey of advisers and wealth managers reports that 71 per cent tip equities as the asset class likely to offer the best returns this year. Meanwhile, 50 per cent of those respondents are recommending to their clients that they actively reduce government bond holdings.
John Clougherty, head of retail at Fidelity Worldwide Investment, notes: “While many have, and continue to, predict a rotation out of bonds, the asset class has produced reasonably strong returns, with UK gilts and UK corporate bonds returning nearly 14 per cent and 10.63 per cent respectively in 2014. [But] the prospect of rate hikes during the year could certainly impact bond returns, thus making strategic bond selection a crucial tool in allocation decisions.”
Ariel Bezalel, manager of the Jupiter Strategic Bond fund, agrees: “In this environment [of low interest rates and tighter credit spreads], we believe an active approach to fixed income allocations can be helpful, in order to ensure that rates, credit and liquidity risk is appropriately managed.”
Stewart Cowley, investment director, fixed income and macro at Old Mutual Global Investors, asserts that there is renewed interest in strategic bond funds, even though they still have something to prove to investors.
“We know the US and UK are on different tracks and the idea that these two groups can… diverge in terms of economic cycle is concerning people and, in that environment, there is a good reason to hedge your bets and have a bit of everything,” he points out.
Mr Cowley sees investors turning to strategic bonds as a way of shielding themselves from movements in capital markets.
“Those double-digit positive returns [in January] can very easily turn into double-digit negative returns at some point because yields are very low and the mathematics say that very small yield movements now create very large capital movements in government bonds,” says Mr Cowley. “So as yields fall, duration increases, so the risks actually increase as the returns decline.
“These are highly risky, highly geared, highly leveraged government bonds out there and I think that’s what investors are rightly very concerned about. That’s why they see the usefulness of strategic bond funds.”
Ellie Duncan is deputy features editor at Investment Adviser