Bond funds quarterly review – future gains unlikely?

Another three months since our last review and we’re still living with the invisible enemy that is coronavirus. Second waves of the virus, both here in the UK and abroad, have threatened any sort of recovery in the economy. Talk has turned from what type of recovery we could see, to how many businesses will survive the next round of lockdowns.

Lots of companies will be hoping actions taken earlier in the year will be enough to see them through another tough period. But another round of lockdowns could mean some companies need to raise more debt to see them through.

In this fixed income quarterly sector review, we look at what's happened to bond markets in recent months, and share our outlook for the future. We also take a closer look at how different areas of the bond market have performed, including which funds delivered the best returns.

This article isn’t personal advice. If you're not sure if an investment is right for you, please contact us about advice. Investments rise and fall in value, so you could get back less than you invest.

What’s the outlook for the bond market?

In the US, the nation elected Democrats Joe Biden and Kamala Harris to be their next President and Vice President. Although they won’t take office until next year, attention is already turning to what policies they might have in the pipeline.

There’s talk of a widely expected stimulus package to further support the economy. But also what might be in store further down the line to shore up America’s finances – the government has already had to spend extraordinary amounts. Some think businesses will have to pay more tax, and fear it won’t help their credit quality.

For fixed income fund managers, it looks set to continue to be a tricky market to navigate. Interest rates in major economies are at rock bottom, and lots of developed market government bonds are yielding less than 1%.

High quality corporate bond yields have also fallen. Federal Reserve data shows that on average, high quality corporate bonds with a 10-year maturity are yielding just 2.15%. Managers hunting for higher yields will likely have to sacrifice credit quality – that will increase risk.

The problem’s unlikely to go away anytime soon. Interest rates are set to remain low as the world tries to recover from the economic damage of coronavirus.

Bond markets have generally risen strongly in the last few decades, but as a bond’s price rises its yield falls. With current yields so low and prices across the board quite high, the chances of significant further gains isn’t very likely. In fact it’s looking more likely that we could see capital losses.

However, we don’t think that means they should be ignored completely, bonds can be a key part of a diversified portfolio. They can give us more stability than shares.

While there might be some more ups and downs to come in the bond market, we still think there’s a place for bonds in most investment portfolios.

As ever, all investments can fall as well as rise in value, so you could get back less than you invest. Investors should hold a well-diversified portfolio. If you’re not sure what that looks like then why not find out how to build an investment portfolio.

For those who need a little more help, it could be worth getting financial advice.

How have bond funds performed?

Gilts, or UK government bonds, delivered an annual return of 5.9%*. This was the highest return over the last 12 months out of all of the major Investment Association (IA) bond sectors.

There’s an inverse relationship between interest rates and the price of bonds. So, when interest rates fall, bond prices rise.

Gilts are particularly sensitive to changes in the interest rate, and this year we’ve seen the Bank of England cut interest rates down to just 0.1%. That’s been good news for bond prices, but also meant that yields have taken a knock as a result. At the time of writing you could earn a yield of just 0.34% for lending money to the UK government for the next 10 years.

Global and Corporate bonds were not far behind over the period, both returning in excess of 4% for investors. Strategic bonds also gave a reasonable return of 3.2%, with Global Emerging markets lagging some way behind with 0.9%.

The High Yield sector delivered the lowest return of the group, with an annual return of -0.2%.

1 Year Bond performance – Total Return

Past performance isn’t a guide to the future. Source: *Lipper IM to 31/10/2020.

Top of the performance tables across all the different bond subsectors over the last year (to 31 October) is Allianz Strategic Bond, co-managed by Mike Riddell and Kacper Brzezniak. The fund has delivered an annual return of 24.1% to investors, compared with the IA £ Strategic Bond peer group’s 3.2%. Although past performance is not a guide to future returns.

In the first quarter of 2020, the fund was positioned pretty defensively as the managers believed the market was more risky than prices seemed to suggest. But in the second quarter of this year, the managers took advantage of attractive valuations in new corporate bond issues. This opportunity came off the back of the US Federal Reserve’s increased support through printing money (quantitative easing).

More recently, before the US election, the managers increased how much they have invested in Asia. They think strong stimulus and a better handle on the spread of coronavirus means there are some attractive opportunities. The managers have also been increasing their weightings to local currency emerging market bonds.

Past performance is not a guide to the future. Source: Lipper IM to 31/10/2020.

Find out more about Allianz Strategic Bond including charges

Allianz Strategic Bond Key investor information

What the research team have been doing

This quarter we continued to look for great managers with strong long term performance potential. There are two parts to our analysis, the data-crunching quantitative side, and the in-depth qualitative side.

As part of our qualitative research this quarter, we’ve spoken to a number of fixed income fund managers. We spoke to Sajiv Vaid, co-manager of Fidelity MoneyBuilder Income to get an update on the fund’s positioning, as well as his latest views. The fund features on the Wealth Shortlist and we think the manager’s conservative approach will deliver good long term returns for investors.

We also spoke to James Foster, co-manager of Artemis Strategic Bond. Foster and his fellow co-manager Alex Ralph have changed the shape of their portfolio this year.

They entered the coronavirus crisis with a relatively high proportion invested in government bonds. A few months later, we saw lots of companies issue new bonds. The managers then reduced how much they had invested in government bonds to take advantage of these new bond issues at attractive prices.

The fund also features on the Wealth Shortlist and we still think that the managers have the potential to perform well over the long-term.

Another manager we spoke to was Lloyd Harris, co-manager of Premier Miton Strategic Bond and Premier Miton Corporate Bond Monthly Income. The Premier Miton Strategic Bond fund launched in September 2019 and aims to give investors a monthly income, along with long term capital growth.

They’ve focused on trying to avoid holding bonds of issuers they think will be worst affected by the pandemic. So, they currently prefer sectors like Utilities, Telecoms, Insurance and Technology. Premier Miton Strategic Bond doesn’t feature on the Wealth Shortlist and isn’t available for direct investment through our platform.

How have our Wealth Shortlist funds performed?

Our Wealth Shortlist selections have delivered a mixed bag of performance over the past year. Some have outperformed their benchmark, and others have underperformed. But that’s expected.

We wouldn’t expect them all to perform in the same way. It’s important for investors to build a portfolio filled with managers who have different approaches and investing styles. Doing this should better investors’ chances of performing well over the long run.

The best performing Wealth Shortlist bond fund in this period was Invesco Tactical Bond. It beat our other picks in its sector and beat the index by 9.47%*, finishing 6.6% ahead of the Strategic bond peer group. Past performance is not a guide to future returns. The fund, which is now co-managed by Stuart Edwards, Jack Parker and Paul Causer, performed well over the coronavirus-related market falls.

The weakest performer has been Artemis High Income. The fund’s managed by Alex Ralph who focuses on higher yielding bonds in order to generate higher income for investors. These higher-risk bonds are often issued by less-creditworthy companies.

Through this year’s turmoil they haven’t held up as well as other higher-quality bonds. This meant the fund lost 2.4% of its value over the period and finished the year 5.6% behind the peer group.

Ralph has the flexibility to invest up to 20% of the fund in UK and European shares in order to boost the fund’s yield. This means she can change how the fund’s invested, depending on her views on the wider economy and the state of bond markets. She’s an experienced fund manager, and has a good long-term track record of delivering for investors.

As the Artemis Corporate Bond fund was launched in October 2019, it’s currently only possible to provide one year of annual performance data.

Here’s how our Wealth Shortlist funds have done. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Strategic Bond – Annual percentage growth

PAST PERFORMANCE ISN'T A GUIDE TO THE FUTURE. Source: *Lipper IM to 31/10/2020.

n/a – Full year data unavailable.

Find out more about Artemis Strategic Bond including charges

Artemis Strategic Bond Key investor information

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Find out more about Jupiter Strategic Bond including charges

Jupiter Strategic Bond Key investor information

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Find out more about Invesco Tactical Bond including charges

Invesco Tactical Bond Key investor information

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Find out more about Artemis High Income including charges

Artemis High Income Key investor information

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Find out more about M&G Global Macro Bond including charges

M&G Global Macro Bond Key investor information

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Find out more about Royal London Corporate Bond including charges

Royal London Corporate Bond Key investor information

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Find out more about Fidelity MoneyBuilder Income including charges

Fidelity MoneyBuilder Income Key investor information

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Find out more about Artemis Corporate Bond including charges

Artemis Corporate Bond Key investor information

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Find out more about Morgan Stanley Sterling Corporate Bond including charges

Morgan Stanley Sterling Corporate Bond Key investor information

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