Fund Selector: Appreciating bond risk

Fund Selector: Appreciating bond risk

Fixed income has never been considered a glamorous part of investing, but it is an exceptionally important asset class that acts as a cornerstone within multi-asset portfolios.

Since the financial crisis, the response of central banks, through measures such as quantitative easing, has meant bond markets have been supported and returns have been exceptional.

As a consequence, I, and many other investors, believe the asset class now looks expensive and so an underweight position is appropriate.

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The potential of an event that could prompt widespread selling reinforces this belief, although no bond manager I have spoken to has given an indication of the catalyst or timing of such an event.

But many investors are exposed to the asset class, so it is worth asking whether they understand the risks?

In my view, many investors remain attracted to the asset class, since they would struggle to fulfil their demands for yield without an allocation.

In fact, to satisfy yield requirements it is quite apparent that within fixed interest many investors have been forced to rotate out of lower risk assets into those with a higher degree of either credit or duration risk.

Some, however, may not always fully appreciate the risk.

One obvious example has been the move from traditional fixed interest into high yield, an area whose risk is more comparable to equities.

Using a strategic bond manager is one way of managing fixed income exposure, but picking the right fund can be daunting as the strategies employed by each manager may differ quite markedly.

One of the managers I believe falls into the lower risk category is Nick Hayes, who runs the Axa Sterling Strategic Bond fund.

Mr Hayes uses a total-return approach and is extremely risk aware. A key theme to his portfolio is a shift to shorter duration assets, which have a lower sensitivity to rises in interest rates that can erode returns from bonds.

Investors must also remain aware of the rising-rate environment that is on the cards, although as always the debate relates to timing and the trajectory of such rises.

It has been nine years since the last rate rise, six since rates last moved in the UK. When this is considered alongside the four-and-a-half-year average tenure of managers in the sector, one has to be cognisant of the average manager’s bias.

Other options for investors include taking exposure to more esoteric subsectors of the asset class, which at times can only loosely be described as fixed interest.

The rise of loan funds that have floating-rate characteristics is a reflection of this trend. In particular, the NB Global Floating Rate fund has gathered significant assets. Due to the underlying illiquidity of the asset class, this investment is structured as a closed-end vehicle.

Fixed income will remain a core component of portfolios for many investors, despite concerns of a potential liquidity event, which could make it difficult to sell out.