Corporate bond funds have a place in the more cautious investor’s portfolio and may be a useful fixed income allocation during current economic and political uncertainty.
These types of funds are not as old as some may suspect, with M&G launching the first in 1994. The IA Sterling Corporate Bond sector has burgeoned since then, with 93 funds sitting in the sector, many of which have a 10-year track record.
A sterling corporate bond fund invests at least 80 per cent of assets in sterling-denominated, corporate bond securities rated BBB minus or above.
One subset of the market has become particularly popular in recent months. Fidelity is one of several firms to launch a short-dated corporate bond fund, investing in investment grade corporate bonds with a remaining maturity of less than or equal to five years. Sajiv Vaid, portfolio manager of the Fidelity Short Dated Corporate Bond fund, explains: “The yield dilemma is as present as ever in today’s low interest rate environment, with cash allocations eroding real wealth. However, cautious investors are wary of extending risk at this point in the cycle.
“While we think yields will remain low – given a fundamental backdrop of high debt, elevated political risk and low nominal growth – this fund caters to those with a cautious outlook.”
According to John Clougherty, Fidelity International’s head of wholesale, they are seeing demand from clients who are looking for “low-volatility solutions to secure modest income”.
The bond market has proved challenging to navigate more recently, having reacted negatively to the election of Donald Trump in the US.
Adrian Lowcock, investment director at Architas, observes bond yields are rising alongside inflation expectations.
“This is bad news for bonds with longer dates to maturity where a rise in interest rate expectations has already hit the market as investors expect inflation to rise in 2017,” he cautions.
“However, we remain concerned that inflationary pressures in the UK are temporary. Therefore, the effects may have already been seen.”
What should investors be aware of when investing in corporate bond funds?
Mr Lowcock says: “A short-duration fund focuses on one part of the market and the manager cannot make money by moving into longer dated bonds. In addition, the corporate bond market in the UK is quite small [with limited] choice available to fund managers.”
For those investors thinking of disposing of bond funds from their portfolio, there are plenty of reasons to remain invested.
Chris Iggo, chief investment officer of fixed income at Axa Investment Managers, considers how investors should look at bond investing heading into 2017 on the assumption growth will be similar to this year and inflation a little higher.
“Think about what bonds can offer – income, protection and diversification in a growth portfolio,” he says. “Despite the low yields there are still opportunities. The income return from bonds has been diminishing over recent years. Indeed, in many markets the balance of return in bonds has shifted towards capital gain and away from coupon return. That makes markets vulnerable when you consider that bonds mature at par. The longer duration parts of the market are where this imbalance is the greatest.”