Brexit, trade tensions and market volatility have all cast a shadow over fixed-income investments
Over the years, bonds have been considered a safe investment for many, designed for income. But recent months have seen fixed income change its natural characteristics to become somewhat riskier than before, no longer providing investors with a safe haven for their money.
Central banks across the world bringing quantitative easing (large-scale asset purchasing) to a close and low yields are just two examples of headlines the space has faced.
Strategic bonds offer one way of owning fixed income while remaining diversified. They have the flexibility to invest in investment-grade corporate, government and high-yield bonds depending on the prevailing market condition.
The idea is for managers to exploit market conditions and invest in the best-performing type of bond, rather than being restricted to one type. They can be run in a similar way to multi-asset funds, except purely within one asset class.
Ideal for investors who do not have the knowledge or expertise of specific fixed income spaces, outsourcing away to a strategic bond manager can help people to diversify by holding a flexible mandate.
At any given time, funds in the Investment Association sector could theoretically sit in any one of the other fixed interest sectors, but in this event, will remain in the Strategic Bond space because it is managers’ stated intention to retain the right to invest across the fixed income spectrum. The IA says funds must invest at least 80 per cent of their assets in sterling-denominated (or hedged back to sterling) fixed interest, excluding convertibles, preference shares and permanent interest-bearing shares.
As of November 2018, there were £50.1bn of funds under management in the Strategic Bond sector, the second-highest fixed income sector after the Corporate Bond space which has £69.5bn in FUM.
The sector is not currently popular with investors, however, as the month of November alone saw outflows reach £563.9m, the second-worst selling sector across the board.
Comparing this with the prior year tells a completely different story. November 2017 saw £1.47bn in net retail inflows in the Sterling Strategic Bond sector, the best-selling space by a long way.
Despite outflows, the Sterling Strategic Bond sector is home to two of the largest funds (by size) across the whole investor universe.
The £43.4bn Pimco Income Fund is the largest unit trust available to UK investors, while the £20.2bn M&G Optimal Income Fund, managed by Richard Woolnough, also tops the list by size; the second-largest in the sector and fifth-largest overall. A lot has changed in the past year and it has been a difficult period for investors to navigate.
Last year started off with fixed income providing security for investors. Yet global uncertainty, including trade tensions, market volatility towards the close of the year and Brexit, all played a part in fixed income ending 2019 with huge outflows.
The fixed income sectors saw sales decline by £1.2bn, with investors favouring mixed asset sectors to help diversify amid unstable and unpredictable markets.
Brexit, of course, continues to dominate the news, while the European Union also faces pressure from Italy over its budget deficit, which has reached 131.8 per cent of GDP, the second-highest in the EU after Greece (178.6 per cent). The UK’s stands at 87.7 per cent and Germany’s at 64.1 per cent.
Looking across the space, which comprises 91 funds from 62 providers, there are a few funds that continue to pop up on top-performer lists. The £1.8bn Royal London Sterling Extra Yield Bond Fund, for example, has seen stable returns over the past one, three and five years. Over three years, the fund has seen a 28.7 per cent return as of 15 January, according to FE figures.
Manager Eric Holt invests in a range of securities, from investment-grade to unrated bonds. He believes the combination of bonds provides a higher yield, without taking the degree of risk associated with high-yielding funds.
A closer look at a selection of funds can be read below.
Funds in focus: A closer look at the big names
After a tricky 12 months across the board, the Sterling Strategic Bond sector has been hit hard when it comes to sales. Here is a deeper look at a selection of funds operating within this space.
Largest fund: Pimco Income
- Launch date: November 2012
- Managers: Alfred Murata, Daniel Ivascyn, Joshua Anderson
- Fund size: £43.5bn
- About: The largest fund available to all UK investors, Pimco Income invests in a range of fixed income securities in order to maximise income, while maintaining a low-risk profile. Its secondary goal is capital appreciation. The managers believe that the fund is best-suited to investors who are targeting a “competitive and consistent” level of income, without compromising on total returns. It is clear why it is popular with investors around the globe, seeing a steady return on investment while beating the sector average since its inception.
Top performer over five years: Royal London Sterling Extra Yield Bond
- Launch date: April 2003
- Manager: Eric Holt
- Fund size: £1.8bn
- About: Investing in a variety of types of bond, this Ireland-domiciled fund holds a broad spectrum of sectors, including industrials, banks and financial services, consumer services and real estate to name a few. Charges vary on the fund but for the Y share class, its annual management charge is just 0.32 per cent, although this could vary by platform. It has a total of 236 holdings in its portfolio. The fund returned 40.25 per cent over a five-year period, according to FE.
Longest-running fund: Lazard Global Active Sterling High Quality Bond
- Launch date: April 1994
- Manager: Ulrich Teutsch
- Fund size: £1.7m
- About: This fund aims to invest in the regulated markets of OECD countries with an investment-grade rating, with the aim of achieving a greater total return than its benchmark, the iBoxx Sterling Overall Index. Despite benefiting from steady growth above the sector average, the fund has suffered from outflows in recent years, with the fund size dropping from £2.7m in August 2016 to its current £1.7m. While outflows like this could be a drop in the ocean for funds such as Pimco Income, they may be damaging to smaller ones.
Highest AMC: Scottish Widows Strategic Income
- Launch date: January 2002
- Managers: Luke Hickmore and Scottish Widows pan-European credit team
- Fund size: £195m
- About: This fund focuses primarily on UK and European corporate bonds, but it also invests in others, such as government bonds. The majority of the fund is in investment-grade securities, although it says that it may have a “significant proportion” with a higher-than-average risk. The fund has an annual management charge of 1.25 per cent for its A share class, but different costs are available for other share classes and minimum investments might be higher.
Most recently launched fund: UBS Strategic Bond
- Launch date: October 2018
- Managers: Kevin Zhao, Lionel Oster and Gordon Harding
- About: The most recent launch in the sector looks for “high-conviction” investment ideas using government and corporate bonds, emerging market debt and currencies. The fund is unconstrained, which the managers believe gives it a “balanced approach” emphasising global diversification. Long-term data is not yet available so it does not appear on the chart above.