Last year, every fund in the UK corporate bond sector underperformed cash and only eight out of 95 funds delivered positive returns.
Interest rates have an inverse relationship with bond prices so the rise in UK rates has caused the price of British corporate and government bonds to fall. The total return and capital appreciation of British bonds have been badly affected. We ask three AFI panellists what they predict for the bond market and whether this will affect their exposure to the asset class.
Killik & Co director of fund research Mick Gilligan says he is less inclined to reduce his exposure to bonds than he was before. He cites the sharp rise in yields over the last few weeks as the main reason. He says: “Our view on bonds is they are less unattractive than three months ago. The spike in yield we saw last week means we would be less inclined to reduce our exposure. I think it would be prudent to not be as underweight bonds as we have in recent years.”
He adds the backdrop for equities remains “much more favourable” than bonds.
Gilligan holds four bond funds across his AFI portfolios – Artemis high income, Henderson preference and bond, Invesco corporate bond and Old Mutual corporate bond.
One thing that appeals to investors and AFI panellists is an increased flexibility in how bond fund managers run their portfolios. One aspect of this is floating-rate notes.
FRNs are bonds with variable rates of interest. The rate of interest is linked to a benchmark rate such as three-month Libor. FRNs are designed to protect investors against interest rate rises, which have an inverse relationship with bond prices.
Gilligan says the wider the remit the better and says managers can look at overseas markets and niche sectors.
Bestinvest research analyst Mark Hinton says bonds are one of his least favourite asset classes. At the last rebalancing, however, he slightly increased his exposure to bonds. This happened by default, he says, while de-risking the portfolios. His investment into bonds and property increased as a result.
Hinton says: “We prefer equities over bonds. Generally the environment is not great for them. We are using bonds for diversification purposes. As rates go up investors are more inclined to go for cash.”
Hinton has 33 per cent exposure to bonds in his cautious portfolio, 13 per cent in balanced and 10 per cent in aggressive. The funds he holds are: Artemis strategic bond, L&G high income and Royal London corporate bond.