Apprehension over the future of equity markets has undeniably driven this behaviour – stockmarkets such as the FTSE 100 have been pushed higher in recent months. Questions remain as to whether these movements are sustainable, similar to the debate being held among fixed income investors.
Junk collector
For a manager wishing to bump up returns in a bond portfolio, securities with a higher risk of default must be sought. The notion that fixed-interest assets are secure is something of a misnomer, as there can be a great disparity in the riskiness of individual companies.
Credit agencies such as Standard & Poors and Fitch rate bonds based on credit-worthiness and assign them ratings ranging from AAA to CC.
Triple-A rated bonds offer the highest level of security by having the strongest probability that companies will meet their obligations. Therefore many government-issued securities such as gilts are placed into this bracket along with large and profitable companies such as Microsoft.
Investors and managers can increase risk by moving down the alphabetic scale, as the increased risk of default pushes up the yields on offer from such bonds. These non-investment grade securities or junk bonds have a credit rating of BB or lower under Standard & Poors’ system.
The higher coupons on offer from this high-yield debt are intended to offset dramatic price swings and failure to honour interest payments.
The upside, especially if the company in question improves its credit rating, can be spectacular returns, and many of the top strategic bond fund performers have benefited from this trend in recent years.
Despite this, high-yield debt has had its fair share of sell-offs over the past two years, including a slump between late October and early November.
The prospect of an unfavourable US election outcome possibly spooked investors, but lingering nerves could signal a buying opportunity, especially as the US economy appears to be strengthening.
Performance
An indication of how individual funds have fared can be seen in Table 1, which lists the 20 best performers over five years. Such funds have displayed relatively low volatility, but also managed to post strong returns over the period, with a couple of exceptions.
The past five years have been reasonably rich for bond managers, especially as low interest rates have driven up prices. But when comparing the sector to others, strategic bond fund holders may have reason to be aggrieved.
The UK index-linked gilt, sterling high yield and sterling corporate bond sectors have all left strategic bonds trailing. The average UK index-linked gilt fund has almost doubled the average strategic fund’s return over three years, and almost trebled it over five.
