In the shadow of a thriving equity bull run, fixed income has become a difficult asset class to find yield in.
It is no wonder then that strategic bond funds have experienced a surge in popularity as more investors opt for managers who have a greater degree of flexibility over what they can hold and where they can invest.
Aside from June 2013 – when all IMA bond sectors saw outflows after from the “taper tantrum” experienced in May – the IMA £ Strategic Bond sector was the only fixed income sector to see inflows in every month from May 2013 to May 2014.
In May 2014, the £ Strategic Bond fund was the fourth most popular sector in terms of net retail sales and received £210m in inflows. The sector now has assets of £31.3bn and eight of its 76 members are running more than £1bn.
But are these funds becoming a victim of their own success and is their nimbleness and flexibility – the factors which made them so popular to begin with – inhibited by their growing assets?
Hermes Fund Managers co-head of credit Fraser Lundie feels this is the case, with managers of strategic bond funds forced to make much bigger and wide-ranging calls as a result.
“A lot of them have moved from being security selectors to being asset allocators,” he says. “Strategic bond funds are absolutely the right way to go [in the current environment] but for the most part they are not providing the nimbleness that is needed.”
The strategic bond sector is home to the biggest fixed income fund on the UK retail market – the £21bn M&G Optimal Income fund, managed by Richard Woolnough.
This fund’s growing size has forced Equilibrium Asset Management investment manager Mike Deverell to sell out of it.
Deverell says: “It is not easy to be nimble with £21bn in assets under management. We used to be with the M&G fund but our concern was it just got too big.
“You have to buy a lot of stuff you do not want to own but have to if you want the fund to be full.
“It might lead to a lower risk portfolio because of the greater diversification but that could dilute returns.”
Other funds are also growing in size, forcing Deverell to reassess his position. The manager cites the Jupiter Strategic Bond fund, which has swelled to over £2bn in size.
Charles Stanley Direct head of investment research Ben Yearsley says strategic bond funds are becoming a “crowded trade” and more focus should be paid to why they are being held in the first place.
Yearsley says: “Strategic bond funds are starting to become a bit of a crowded trade. The trouble is investors see it as a one-way bet and people think that when rates rise they will be fine.
“We use a few strategic bond funds but I have a slight undertone of worry that investors feel they cannot do any wrong. You are reliant on the fund manager and their skill and timing – they are not an elixir. For instance, the Old Mutual Global Strategic Bond fund has been pretty disastrous.”
The £753m Old Mutual fund, managed by Stewart Cowley, has posted third quartile performance over one, three and five year periods to the end of June, according to FE Analytics.
Harwood Capital multi-manager Richard Philbin is still invested in Woolnough’s £21bn fund and sees an advantage with its size over an equivalently large equity fund.
“I am still with Woolnough, just because he has a lot of money under management,” he says. “He gets greater control with more assets under management.
“Unlike Woodford, who ran a 70-stock portfolio where you could see the changes being made, Woolnough has 700 lines of stock. He probably has greater flexibility than someone like Woodford but yes there would be issues with sector-wide calls.”
However, Philbin is concerned some strategic bond fund managers are not being as strategic as they could be and are not exploiting the wider fixed income universe they are allowed to invest in.
He says: “When it comes to strategic bond fund managers I do ask what they actually do – they can invest through many risk-rated levels of credit but a lot of them will stay within a certain credit area.
“Even though they say they are strategic it does not mean they will actively play the game. Richard Woolnough is actually quite strategic and moves around. A lot of managers will tend to stay in the BB-rated area of debt.”
|Biggest funds in £ Strategic Bond sector|
|M&G Optimal Income||£21,330m||Richard Woolnough and Stefan Isaacs|
|Pimco GIS Diversified Income||£7,054m||Eve Tournier|
|Invesco Perpetual Monthly Income Plus||£3,983m||Paul Causer, Paul Read and Ciaran Mallon|
|Jupiter Strategic Bond||£2,116m||Ariel Bezalel|
|Pioneer Sicav Strategic Income||£1,937m||Kenneth Taubes|
Philippa Gee, managing director, Wealth Management
“Even though everyone moans about it, fund size is more of an issue for the fund manager. It should not be a problem if you expect the manager to still perform. But if size gets in the way of performance then it becomes an issue. I leave the fund size to the manager but if the performance gets impacted then they will have a lot of questions to answer.”