The latest figures from the Investment Association (IA) show that net retail sales into the fixed income asset class has remained consistent in 2015, with £128m flowing into bond funds in March 2015. While the asset class overtook equities, which saw net retail inflows of just £108m, fixed income lagged both property and mixed asset funds.
However, the popularity of the latter may in some part explain the resilience of the IA Sterling Strategic Bond sector, which in the past 12 months to March 2015 is the only fixed income sector not to record negative retail flows for at least one month.
The definition for a fund in the IA Sterling Strategic Bond sector is fairly broad, stating: “Funds which invest at least 80 per cent of their assets in sterling-denominated (or hedged back to sterling) fixed interest securities.”
This definition describes one of the benefits and potential drawbacks of these funds. Like multi-asset funds, a key feature is diversification based on duration, geography or credit rating, meaning comparing funds can be difficult. As the IA itself acknowledges: “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.”
For the most part, however, this ‘strategic’ approach to fixed income is paying off for investors. In the 12 months to April 30 the top performing fund in the sector, the Pimco GIS UK Sterling Long Average Duration fund, delivered a return of 21.05 per cent, according to FE Analytics data. Although at the other end of the scale, three of the 75 funds in the sector recorded a loss over the same period.
Chris Iggo, chief investment officer for fixed income at Axa Investment Managers, notes: “In recent years it has become very difficult to identify what constitutes a risk-free asset… Typically our approach is to hedge the foreign exchange risk in bond portfolios but that still leaves us having to manage interest rate, credit and liquidity risk.”
Daniel McKernan, head of sterling investment-grade credit at Standard Life Investments, notes that the “pull of quantitative easing [in Europe] will continue to exert itself for a while. We think it will have a knock-on effect, not only into some of the periphery names but also through into corporate investment grade and high yield.”
With such strong macroeconomic forces, Mr Iggo advocates flexibility as the key approach for fixed income investors, as they “face a difficult time ahead”.
He adds: “All of these risks… constantly change as the macroeconomic, business, policy and political cycles evolve. Having a strong focus on the top-down influences on markets, an unemotional assessment of valuations… and a flexible approach to managing bonds in a liquidity constrained environment, should generate high-quality returns through the cycle.”
Baillie Gifford Corporate Bond
Even though it has ‘corporate bond’ in its name, this £494.3m fund sits in the more flexible strategic sector. Managed by Stephen Rodger and Torcail Stewart the fund aims to produce a high level of monthly income by investing in the ‘best ideas’ across investment grade and high yield, with the use of derivatives also an option. The fund is top quartile in the sector across one, three, five and 10 years to April 30 2015, with its five-year return of 55.77 per cent significantly outperforming the sector average of 32.78 per cent.
Invesco Perpetual Monthly Income Plus
The trio of Paul Causer, Paul Read and Ciaran Mallon manages this £4.22bn fund. It aims to achieve a high level of income by investing mainly in corporate and government high-yielding debt, as well as equities and cash. At the end of March 2015 the fund held 84.45 per cent in fixed interest, with 15.13 per cent of the portfolio in equities. It has ranked top quartile in the sector across three, five and 10 years, although its 12-month performance has lagged, slipping into the second quartile with a return of 5.36 per cent just ahead of the sector average of 5.14 per cent.
Royal London Sterling Extra Yield Bond
Managed by Eric Holt this £1.06bn fund has appeared in the Investment Adviser 100 Club in both 2013 and 2014. Its aim is to achieve a high level of income with a specific target of delivering a gross redemption yield of 1.25 times the gross redemption yield of the FTSE Actuaries British Government 15-year index. The fund is ranked top quartile in the sector across three, five and 10 years, with its five-year return of 66.91 per cent more than double the sector average of 32.78 per cent. Its largest allocation is to credit-rated BB or below at 44.8 per cent of the portfolio, while the fund also has 30 per cent invested in the banks and financial services sector.