Strategic Bonds  

What makes a bond fund strategic?

This article is part of
Guide to strategic bonds

What makes a bond fund strategic?

Strategic bond funds are a way of maximising returns from a diversified pool of different types of bonds.

The only thing one bond has in common with another is that they are all forms of debt; the institution or company issuing the bond is needing to borrow money and in return offers a yield, which is the interest ‘reward’, for lending them the money.

Nathan Sweeney, senior investment manager at Architas says that given the many drivers of returns, investing in fixed income is never easy. Strategic bonds aim to ease some of the more complex decision making associated with seeking income.

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He says: “You also have the difficult decision of choosing government or corporate bonds and with the latter if you want companies with a good rating and a lower yield or a bad rating and a higher yield.”

This is where the strategic bond comes into play; you have a manager or team of people who decide where the best opportunities lie within the whole bond spectrum. 

However Mr Sweeney adds that many funds in the sector “have a set asset allocation, are not very strategic and stick to a set formula”. “There are of course exceptions to this and these are the funds we look for.”

He gives the example of the TwentyFour Dynamic Bond fund. “In our opinion it truly embraces the strategic bond sector by being, as the name suggests, very dynamic in the way it allocates to different fixed income sectors. The company also has a lot of expertise in more alternative areas, such as asset backed securities, compared to its peers.

“The fund holds more illiquid instruments, which can cause issues when the market is falling. When the market sells off they might not offer the same level of downside protection, although their performance in falling markets has improved in recent years. The fund does use derivatives, which can offer some protection when they have concerns about the market. 

"One of the potential drawbacks is the size of the fund, as it is currently around £1.4bn, but this is still relatively small compared to other funds in the sector.”

Thomas McMahon, senior analyst at Financial Express explains that strategic bond funds aim to allocate between government bonds, investment grade corporate bonds and high-yield bonds. 

These are what he calls “the three core areas of fixed income”.  

“These funds try to produce superior returns through the credit cycle by allocating to government bonds when recessions are near and to credit when the economy is improving and companies are deleveraging.”

Broad flexibility

Ashis Dash, associate director of fixed income strategies at Morningstar says: "Strategic bond funds have the broad flexibility to invest across global rates, credit and currency markets (each of these affect the fund’s risk-return profile in a different way) as well as use derivatives liberally.