In Focus: Fixed income  

Most bond sectors are straightforward, but not IA Strategic Bonds

Eduardo Sanchez

Eduardo Sanchez

Bond fund sectors, for the most part, are relatively straightforward with well-defined parameters and clear benchmarks against which performance can be measured.

This means that an adviser, having decided on a desired allocation to a certain sector, can choose a fund to fulfil that allocation by comparing its performance against its sector and index.  

Not so for the IA Strategic Bond sector. The only requirement to which funds within this sector must adhere is a minimum 80 per cent weighting to Sterling-denominated fixed income issuance.  

However, the breadth of such issuance is so wide that strategic bond funds frequently exhibit completely different exposure profiles.  

There is no common index against which they can be compared, and funds’ asset allocations can change over time, making it very challenging for fund selectors and advisers to make meaningful comparisons between strategies.  

To add to the confusion, it is at the manager’s discretion to decide whether their fund sits within this sector and their objectives might be vaguely expressed, such as delivering risk-adjusted returns through exposure to the opportunities that are open to them.  

All this combines to create a very mixed set of undetermined investment offerings, and often requires a leap of faith in a manager’s ability to deliver the best risk-adjusted returns.  

Navigating this complex landscape successfully requires a solid understanding of how funds are structured and the parameters they impose.

Equipped with this knowledge, a fund selector can then sub-categorise the sector into smaller, more homogenous groupings to allow more meaningful comparisons from both a performance and expected investment outcome perspective.  

This provides an adviser with greater clarity when assessing conviction in a manager, as there is a baseline governing what they are trying to achieve, against which other funds they are comparable, and their success in delivering on their objective over time.  

We have identified four sub-sectors that facilitate this like-for-like comparison, although they cannot be set in stone given the flexible parameters governing these funds and the fact that they are all actively managed, meaning their exposures may alter over time.

The first three of the four sub-categories mark differing points along the risk spectrum.

As an investor advances from one to the next, the expectation is that the additional volatility incurred will be rewarded with a higher return over time.  

The first two sectors, low risk and medium risk, are multi-sector, meaning that they may contain a mix of investment-grade and government debt, high yield and emerging market debt, securitised credit and asset-backed securities, inflation-linked bonds and some duration risk.  

Funds within these groups are likely to make up the defensive component of a fixed income allocation with some level of income.  

The third group, higher risk, comprises funds that are mainly credit-focused, with a closer correlation with broader markets and a greater emphasis on income generation.