Fixed interest is traditionally seen as one of the more conservative asset classes but Eric Holt’s £1bn Royal London Sterling Extra Yield Bond fund is anything but. This is a fund that has delivered more than 150 per cent over the past six years. Bonds in general have had a strong period but Holt has been a revelation, more than doubling the returns of UK gilts and the IA Sterling Strategic Bond sector average and outperforming the FTSE All Share.
So how has he done it? While Sterling Extra Yield Bond sits in the Strategic Bond sector, it is for all intents and purposes a high yield bond fund. Holt has next to nothing in investment grade, preferring debt-rated BBB and below. In many ways the fund is even riskier than high yield funds in that it has more than a third of assets in unrated bonds. However, the flexibility of IA Strategic Bond means it qualifies.
The manager’s sensitivity towards valuation and willingness to search in niche areas has enabled him to deliver equity-like returns. A hefty allocation to financials since 2011 has been a big help, which still has a 30 per cent weighting in the fund. Holt made many of his best investments in the aftermath of the financial crisis, helping him to an average return of more than 20 per cent in 2009 and 2010.
The fund is currently yielding 5.33 per cent but it is not uncommon for this figure to be upwards of 7 per cent. Indeed, it has been one of the best income-paying funds of its kind in recent years. According to FE data, an investment of £1,000 six years ago has delivered dividends worth £632. The same investment in more popular funds in the sector such as M&G Optimal Income and Fidelity Strategic Bond has resulted in income worth £265.72 and £275.87 respectively.
While the Sterling Extra Yield Bond has been one of the more volatile in its sector, it has a much lower annualised risk score than the average high yield fund over six years and almost half of that of UK equities. FE data shows the fund has the highest Sharpe ratio in its sector over five- and six-year periods and is second to only GAM Star Credit Opportunities over three.
The fund hunts in the racier parts of the bond market but Holt ensures it is always adequately protected against default risk by being highly diversified. It currently has 181 holdings. Holt looks to further offset the risks associated with sub-investment grade and unrated debt by holding a sizeable portion of assets in secured bonds, meaning they are backed by a charge on specific assets. Unsurprisingly, the risk/return profile of the fund has attracted strong interest and assets have almost doubled over the past
three years. But whether now is a good time to buy remains to be seen. One thing is for sure: investors expecting another 150 per cent from Holt over the next six years are set to be disappointed.
High yield had a wobble in the second half of last year and the uncertainty caused by the eurozone crisis in 2011 also caused a decent sell-off. However, the ride has been extremely smooth on the whole.
The asset class has been one of the biggest beneficiaries of unprec-edented loose monetary and fiscal policy in recent years but this significant headwind is subsiding.
Invesco’s Paul Causer is one of a number of managers who expects interest rates in the US to rise this year, which is generally seen as a negative for holders of debt. There is no direct relationship between rising interest rates and high yield underperformance but even the suggestion of a rate rise during the 2013 and 2014 taper tantrums caused a sizeable sell-off. How markets react when rates actually rise is anyone’s guess but a fund that has had as good a run as Royal London Sterling Extra Yield Bond looks vulnerable.
Holt’s track record during significant market turbulence does not make for pleasant reading. In 2008 he lost more than the FTSE All Share (33.38 per cent), putting him second bottom of the sector. In spite of the losses over the 12-month period, the fund is still top quartile over the market cycle.
We are not necessarily heading for another 2008 and even if we are the backdrop for a fund like this is completely different. However, the question as to whether it is ripe for profit-taking needs to be asked. Who knows, in a few months’ time, it may present investors with a much more attractive entry point.
Josh Ausden is head of content at FE Trustnet