Bond yields are becoming harder to find. Craig Rickman explores the challenges facing the Sterling High Yield sector
The hunt for income is what tends to drive the majority of investment decisions. Even if growth is the initial goal, in most cases the aim is to accumulate a fund that can be used to generate income in the future.
Finding income has become more challenging in the past few years, largely as a result of the global economic crash in 2008. Annuity rates, cash deposits and bond yields have all progressively worsened, leaving investors scratching their heads about how to find the desired levels of income.
However, good quality yields are still very much available, and although taking a degree of risk may be necessary, some managers are managing to achieve impressive returns with low levels of volatility.
Gilts
The Bank of England is understandably cautious about the UK’s economic future and has introduced a number of measures to apply the brakes.
Things have been eerily calm post-Brexit, but that seems more due to fact that the severance is yet to take place. But quite clearly the Bank’s governor, Mark Carney, feels a “prevention rather than cure” approach is necessary – which explains the decision to halve interest rates and boost quantitative easing.
This move to reduce interest rates shows an interesting and fairly complex relationship with the performance of bonds, especially those issued by governments. Although future issues of gilts will see rates reduced, those already in operation with substantially higher rates become far more attractive.
When issued by the Treasury, gilts are purchased by investors at par value (usually £100) with a fixed coupon (interest rate) and term attached. The value of this coupon is then paid out twice a year – for example, a Treasury 2 per cent Gilt 2026 bought for £1,000 would generate payments of £10 every six months. These can be traded at above or below par value, which is driven by economic conditions at the time.
Put simply, falling interest rates make higher yields on existing gilts attractive and therefore investors are likely to be more willing to pay more than par value.
Performance
Despite the yields on new issues of government bonds plummeting across Europe continent over the past few years, the performance of funds in the Investment Association Sterling High Yield sector has been impressive.
Table 1 (bottom of article) shows the top 20 funds listed in order of performance over five years based on an initial £1,000 investment, according to FE data. Over this period, the average fund has achieved growth of 7.1 per cent pa – a figure that any equity-based fund manager would be proud of. Yields were particularly impressive around the turn of the decade with the average fund seeing returns over 9 per cent for three consecutive years between 2011 and 2014.
The top-performing fund, the £126.7m Invesco Perpetual High Yield fund, has grown by an average 9.7 per cent – providing a strong indication of the reduced volatility within high yield bonds. During 2012/13, the fund grew by 21.8 per cent, showing that huge returns are still possible in assets that investors generally lean towards to provide security.
