Kames Investment Grade Bond - removed from Wealth 150

Richard Troue | Thu 10 November 2016

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Summary

In recent years bond yields have fallen to historically-low levels. Corporate bonds currently yield in the region of 2.7% (gross of taxes or charges). We fear investors in this fund will receive too little reward, once the relatively high ongoing charge (currently 0.79%) has been deducted, for the risks they carry.

We regularly review the performance potential and value for money Wealth 150 funds offer. When we consider the performance potential of Kames Investment Grade Bond alongside the current ongoing charge of 0.79%, we do not believe the overall proposition should command such a high fee. We have therefore taken the decision to remove the fund from the Wealth 150.

The Wealth 150 is our selection of the best funds across the major sectors with competitive ongoing management charges. In recent years the cost of investing has generally been driven down and we have worked hard to ensure Hargreaves Lansdown clients can access exceptional fund managers at the best prices.

Our View

To justify high charges investors need to be confident a fund manager can add notable value, through superior bond selection, or management of the interest rate risk associated with bonds, for example.

We consider Stephen Snowden to be a highly-capable bond fund manager, but we fear he will not deliver sufficiently superior returns to justify the higher fees charged to investors. Indeed, recent performance has been subdued.

We believe there are bond fund managers available who are unencumbered by such high fees and have a better chance of delivering returns in excess of peers and the benchmark index over the long term. Our favourites feature on the Wealth 150+.

Rationale for removal from Wealth 150

A premium fund management charge is only justifiable for a high-calibre fund manager with a demonstrable track record and, more importantly, where we are confident superior performance is likely going forward.

Stephen Snowden has a good long-term track record. However, in the current environment we consider the fund’s charges to be a barrier to performance prospects. To explain why it is necessary to consider the performance of the corporate bond market over recent years.

As interest rates have fallen demand for income has fuelled the popularity of corporate bonds and returns have been strong. Yields have been driven down and prices up. This inevitably reduces the potential going forward.

The yield on the fund’s benchmark, the iBoxx Sterling Non-Gilt Index, is just 2.7% (gross of taxes or charges). Even before fees are considered this is not a particularly high reward for the risk of lending to companies, and the inflation and interest rate risk associated with an investment in bonds.

An ongoing charge of 0.79% wipes out a significant proportion of this yield. Furthermore, after such a strong run future returns from corporate bonds could be lower. In this environment a fund’s ongoing charges have a much greater dilutive impact on returns, particularly when compounded over the long term.

Performance review

Stephen Snowden is willing to take an alternative view and invest his fund differently to many peers. This often results in a higher-risk portfolio, in our view, with the potential for good performance if the manager is proved correct.

Performance during the 2008/09 financial crisis is indicative of the higher-risk approach. Stephen Snowden’s fund performed poorly, partly because he had significant exposure to Financials bonds and ‘collateralised debt’ (bonds backed up by the value of pubs, for example).

Past performance is not a guide to future returns.

Source: Lipper IM to 01/11/2016

Performance subsequently improved and has continued to be solid, overall, since Stephen Snowden assumed responsibility for this fund in September 2011. Recent performance has been weaker though and the fund underperformed its benchmark over the past year and we continue to believe the fund could struggle in a tougher environment for bonds.

We do not suggest an imminent reversal in the fortunes of the bond market is upon us, but with yields at such low levels there is increased potential for capital loss. Indeed, the fund’s benchmark fell over 3% during October alone as rising inflation, caused by weaker sterling pushing up import prices, reappeared on investors’ radars.

Past performance is not a guide to future returns.

Source: Lipper IM to 01/11/2016

Inflation is negative for bonds. It erodes the value of investors’ capital and the fixed-interest payments received, and could mean interest rates rise faster and further than expected. This reduces the attractiveness of fixed-interest payments further and investors demand higher bond yields in the face of more attractive returns on cash. When bond yields rise prices fall.

We think it is unlikely interest rates will rise in the UK in the short to medium-term. While this remains the case any sell-off in the bond market could mean yields look attractive to income-starved investors once more. Increased demand could see the market rise again, but after such a strong run investors should be alert to the potential risks. The manager can have exposure to high-yield bonds and use derivatives, both of which add risk. A proportion of the fund could also be invested in bonds issued or guaranteed by an EEA state.

Past performance is not a guide to future returns.

Source: Lipper IM to 01/11/2016

This article is not personal advice. If you are unsure of the suitability of an investment for your circumstances please seek advice. Yields are variable and not guaranteed and are not a guide to future returns.

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