Royal London Sterling Extra Yield Bond Class B Income

There has been strong demand for 'safe haven' investments in recent months, and in particular for UK government bonds (gilts), which have rallied causing yields to fall. The yield on 10-year gilts is around 2.6% having fallen below 2.3% a month ago. Prices have slipped back somewhat following the Bank of England's announcement of further quantitative easing (QE).

The picture in the corporate bond market has been quite different. Concerns surrounding the potential for sovereign defaults in Europe, and the associated risks of contagion throughout the financial system, have caused a more prolonged sell-off, though certainly nothing to match the dramatic falls in 2008. It could still spell an opportunity though. The 'spread' between corporate bond yields and gilt yields is high presently, effectively meaning investors are paying a hefty price for the relative safety of government bonds, and that many corporate bonds look relatively good value.

According to Eric Holt, manager of the Royal London Sterling Extra Yield Bond Fund, this is especially the case given the improvement in corporate balance sheets since the credit crisis unfolded. In 2008 over-indebtedness was more widespread and businesses were more vulnerable to deteriorating economic conditions. Companies are now sitting on an estimated £65bn of cash, twice pre-recession levels, making a 2008-style bond market panic far less likely. As such Eric Holt has positioned the fund for a subdued environment rather than a disastrous one.

His process essentially involves taking positions in bonds which he believes are valued pessimistically, and therefore offer a higher yield than they potentially 'should'. Currently he favours certain financial bonds (this is where 30% of the fund is invested), and has recently bought Portugal Electric bonds. According to Eric Holt the current yield on these is 10%, and they are trading at a near 15% discount to redemption value, so there is also the possibility of capital gains too, although there are no guarantees and remember bonds can fall in value as well as rise, so you could get back less than you invest. Many investors are avoiding Portugal and other European nations troubled by sovereign debt issues. However, Eric Holt believes that widespread pessimism has created an opportunity and the company is in reasonable shape, deriving much of its earnings from Brazil.

The Royal London Sterling Extra Yield Bond Fund invests in a different range of fixed interest securities from most bond funds. Only a small amount is invested in 'investment grade' bonds (those issued by high quality companies where the risk of default is perceived to be low), and exposure is primarily to more risky high yield bonds, as well as bonds without a credit rating. The income on offer can be attractive, and the fund currently yields over 7% (variable, not guaranteed), although these are higher risk areas.

This fund is certainly on the adventurous side of bond investing, but for investors comfortable with the risks of this 'special situations' style we believe it offers an attractive way to potentially benefit from the opportunities in the high yield bond market over the long term. It therefore remains on our Wealth 150 list of favourite funds in each sector. Please note as an offshore fund you are not normally entitled to compensation through the UK Financial Services Compensation Scheme.