Most investors gain exposure to bonds via funds run by an experienced portfolio manager. There are several different types of bond fund:
- Corporate bond funds – focus on higher-quality, investment grade corporate bonds. These bonds have a relatively low risk of default and are more likely to meet their payment obligations. They tend to offer lower yields as a result.
- High yield bond funds – invest in bonds paying higher levels of income. This compensates investors for the greater level of risk taken, as these bonds are issued by companies with a greater chance of defaulting on their debts.
- Strategic bond funds – have the freedom to invest across the fixed-interest spectrum, including government, corporate and high-yield bonds, as well as some flexibility to invest overseas. Some focus more on income generation, while others are more concerned with capital growth or sheltering capital.
- Global bond funds – as well as investing in government and corporate bonds issued globally, these funds can hold bonds denominated in currencies other than sterling. This means they can have significant exposure to foreign currencies. Similar to strategic bond funds, their objectives will vary from fund to fund.
- Gilt and index-linked funds – predominantly invest in bonds issued by the UK government. Index-linked bonds typically increase any income paid and the capital repaid at redemption annually in line with inflation.
Our view on the Fixed Interest sector
Bond funds have historically appealed to income-seeking investors, given the fixed level of interest they pay. They are typically viewed as ‘lower risk’ than investing in a company’s shares. This means they can help limit some of the volatility normally associated with pure stock market investing.
We believe bonds can play a part in a diversified portfolio. However, in recent years a number of risks have built up that investors should be aware of.
Bond markets have performed well for several years. At the same time, yields have fallen to the point where the scope for significant further gains is limited and the income on offer has reduced materially. There is little potential reward on offer for assuming the risks of lending to companies and governments, and there is plenty of scope for yields to rise and prices to fall. This exposes investors to potentially wider swings in the value of their capital than they have become accustomed to in recent years and increases the potential for losses.
The main risks to bond investors are a faster than expected rise in inflation or interest rates (interest rate risk), a deterioration in economic growth that causes companies to struggle to service their debts (default risk), or a broad sell-off across the market that makes it difficult to sell bonds at a reasonable price (liquidity risk).
At present, the environment for bond investors looks relatively benign and we don’t foresee an imminent reversal in fortunes. The risks are worth keeping in mind though, particularly by investors who traditionally looked to bonds to provide an attractive income and reduce volatility.
Our favourite funds across the main fixed-interest sectors feature on the Wealth 150 list of our favourite funds. In the current environment we prefer ‘strategic’ bond funds, given the additional flexibility they have to seek returns across all areas of the bond markets. Investors who prefer a professional fund manager to run a diversified portfolio of bond funds on their behalf may wish to consider the HL Multi-Manager Strategic Bond Trust. We feel the additional costs associated with running a multi-manager fund are justified by the benefits of this approach.
The HL Multi-Manager funds are managed by our sister company HL Fund Managers.
Over the past year global bond markets delivered mixed results. Higher-risk global high yield bonds and emerging market debt performed well, although sterling's weakness against some of the world’s major currencies dampened the returns from overseas markets for UK investors.
UK corporate bonds delivered reasonable returns over the 12 month period. UK government bonds managed a small gain, but UK inflation-linked government bonds were particularly volatile as investors grew concerned about the potential for rising inflation and interest rates.
Funds investing predominantly in high yield bonds performed best over the year, while corporate bond and strategic bond funds delivered almost identical returns. Global bond funds had to contend with a weaker pound, which meant they delivered weaker results.
Bond sectors - one year performance
Past performance is not a guide to future returns. Source: Lipper IM, correct at 31/12/2017.
Over the longer term bond markets across the globe have performed remarkably well, particularly over the past decade, although this should not be seen as a guide to future returns.
A combination of low interest rates and quantitative easing has pushed bond yields down to historically low levels. When yields fall bond prices rise, so over the past few years investors have enjoyed heathy gains, as well as income, from bond investments.
If the economic outlook deteriorates or remains benign, interest rates could stay lower for longer, which means bonds have the potential to remain popular with investors and could keep prices buoyant. Equally, periods of volatility should not be ruled out, particularly if we enter a rising inflation or interest rate environment.
|Annual percentage growth|
| Dec 12 -
| Dec 13 -
| Dec 14 -
| Dec 15 -
| Dec 16 -
|IA £ Corporate Bond||0.2||9.9||-0.5||8.9||5.0|
|IA £ High Yield||6.6||1.1||-0.7||9.9||6.1|
|IA £ Strategic Bond||2.7||6.3||-0.4||7.1||4.9|
|IA Global Bond||-2.5||5.0||-0.9||14.3||1.7|
Past performance is not a guide to future returns.Source: Lipper IM, correct as at 31/12/2017.
Our favourite funds in the sector
Some of these funds invest in high yield bonds and use derivatives, both of which increase risk. For more information, please refer to the Key Investor Information Document for the specific fund. Remember all investments can fall as well as rise in value so investors could get back less than they invest. Past performance is not a guide to the future.
Other funds in the sector
Source for performance figures: Financial Express
Strategic Bond. Richard Woolnough invests globally with the aim to deliver the ‘optimal’ income stream, plus some capital growth, from a blend of government bonds, corporate bonds, high yield bonds and, occasionally, shares.
The manager has kept the fund’s duration relatively short and this should afford some protection against rising interest rates. This previously acted as a drag on the fund’s performance, but started to help in 2017. Over the past year the manager has found more value in higher-quality, investment grade corporate bonds and less so in high yield bonds. Exposure to the latter has therefore been reduced. Richard Woolnough has a good track record of getting the bigger picture economic calls correct, and moving the fund between sectors and different parts of the bond market. This has added a lot of value for investors over the long term. The fund can invest up to 35% in bonds issued by EEA member states and in emerging market debt, which increases risk.
Strategic Bond. This fund invests differently to most conventional bond funds. It could offer some shelter against short-term inflation shocks, and inflation-beating returns over the longer term.
The managers invest in short-dated, index-linked government and corporate bonds. In addition, they use derivatives to add an element of corporate bond exposure alongside the index-linked bonds. This flexibility gives the managers greater scope to achieve an inflation-beating return, although it adds risk. This fund is not designed to provide investors with an income, but it has provided investors with inflation-like returns over the long term. We feel it could be used to form part of a more defensive portfolio, or one that aims to shelter capital from the impact of inflation. The fund can invest up to 35% in bonds issued by EEA member states.
Corporate Bond. This fund mainly invests in investment-grade corporate bonds. It’s run in a conservative way and the managers aim to generate an attractive income without taking excessive risks.
The fund is run by Ian Spreadbury and Sajiv Vaid – two highly-experienced bond fund managers. The majority of the fund invests in bonds issued by high-quality companies. It also invests in sub-sovereign bonds, which are issued by organisations such as the European Investment Bank. The managers’ cautious investment approach has held back returns against a strongly-rising bond market in recent years. However, the fund has outperformed the broader corporate bond market over the longer term and we would expect the investment process to work well in a tougher environment for bonds.
Corporate Bond. The manager mainly focuses on investment-grade corporate bonds. He is prepared to seek opportunities off the beaten track and invest in bonds overlooked by other investors to generate an attractive income.
We like Jonathan Platt's unique perspective on bond markets. For example, he invests in bonds with a claim on assets, such as property. In this instance, if the company issuing the bond defaults and can’t pay the interest due, bondholders have first claim on this property. This approach has worked well over both the short and long term, and our analysis suggests good bond selection has driven returns over the past year. Investing in more unusual areas of the bond markets makes the fund a higher-risk proposition however. Please note the fund takes charges from capital which can increase the yield, but reduces the potential for capital growth.
Strategic Bond. This fund invests flexibly across the fixed-interest spectrum. The managers alter the fund depending on where they see the greatest value, and when they feel economic or market conditions have changed.
James Foster and Alex Ralph believe there is currently less value to be found across the bond markets. They are particularly cautious about government bond markets, which have performed strongly for several years and have limited scope to rise much higher, while the yields on offer are also relatively unattractive. They are more optimistic about bonds issued by companies, including some financial firms, and this has benefited the fund over the past year. We believe the fund is a good option for a combination of capital growth and income from the bond markets.
Strategic Bond. Eric Holt and his team focus on undervalued and overlooked areas of the fixed-interest markets. This includes bonds without a credit rating or those with a claim on assets, such as property or cash flows.
The fund delivered good returns in 2017. Our analysis suggests the manager has added value and generated an attractive income through good bond selection. A combination of investments in niche areas and more traditional areas of the government, corporate, and higher-risk high-yield bond markets has also worked well over the long term. This fund is on the adventurous side of bond investing and performance could be volatile during more turbulent times for bond markets. Over the long term we expect the team to deliver good returns, predominantly in the form of income. Please note as an offshore fund you are not normally entitled to compensation through the UK Financial Services Compensation Scheme.
Strategic Bond. In addition to investing in government, corporate, and high-yield bonds, the manager invests up to 20% of the fund in shares. This could boost income and capital growth, but increase volatility.
The fund has performed well over the past year. Our research shows good bond selection and some exposure to shares boosted returns. The fund is currently biased to the financials sector – investments in bonds issued by both banks and insurance companies helped recent performance. The equity portion is also biased towards financials and invests in the shares of companies such as Legal & General and Nordea Bank. We like the manager’s flexible investment approach, although a bias towards high yield bonds, in addition to exposure to stock markets, makes this fund a higher-risk and more volatile proposition than the average fund in the sector. Please note the fund takes charges from capital which can increase the yield, but reduces the potential for capital growth.
UK Gilt. This fund invests in a broad spread of UK government bonds, also known as gilts. It aims to track the performance of the FTSE Actuaries UK Conventional Gilts All Stocks Index.
Gilts are issued by the UK government and sit at the lower-risk end of the bond spectrum. This is because it’s highly unlikely the UK government would default on its debts and be unable to pay the interest due to bondholders. This low-cost fund is one of our favoured ways for investors who wish to gain broad exposure to UK government bonds. The fund invests in a concentrated number of investments, which typically increases risk, but this reflects the makeup of the index it replicates. Please note the fund takes charges from capital which can increase the yield, but reduces the potential for capital growth.
Global bond. This fund aims to track the performance of the Bloomberg Barclays World Government ex UK Inflation Linked Bonds (Hedged) Index by investing in a diversified range of index-linked bonds from across the globe.
Inflation-linked bonds differ from conventional government and corporate bonds in that the value of any income and capital paid typically increases annually in line with inflation. This funds aims to provide investors with protection from rising inflation across the globe, rather than in the UK. Inflation-linked bonds issued by the US government comprise a large part of the index this fund tracks, which means more than half the fund is currently invested in the US. We feel it could provide diversification to a wider fixed-interest portfolio.
Strategic Bond. This fund invests in both stock and bond markets in order to pay a regular income. Up to 20% can be invested in high-yielding UK shares, with the remainder invested in bonds.
The fund performed well over the past year, helped by investments in financial company bonds and shares. Individual stock and bond selection had less of an effect, however. This fund benefits from the experience of both the Fixed Interest and UK Equity teams at Invesco Perpetual. We have high conviction in Paul Read and Paul Causer, who manage the bond portion of the fund, but we currently prefer to access their expertise through other funds they manage. We also currently favour other funds in this sector and the fund does not feature on the Wealth 150. Please note the fund takes charges from capital which can increase the yield, but reduces the potential for capital growth.
Strategic Bond. This fund combines the managers’ best ideas across the investment-grade and high yield bond markets, without making significant calls on specific sectors or wider economic issues.
Stephen Rodger and Torcail Stewart have delivered respectable performance over both the short and long term. Unusually for a bond fund, the managers tend not to consider factors such as the wider economic environment or duration (a measure of a bond’s sensitivity to changes in interest rates). Instead they focus purely on the prospects for individual bonds. In our view, individual bond selection will not always be the single driver of returns and we expect wider factors to also have an impact on the performance of bond funds at times. We believe the managers have the potential to deliver good returns for investors over the long run, but currently have higher conviction in other funds in this sector.
Latest research updates
Please note the research updates are not personal recommendations to trade. If you are unsure of the suitability of an investment for your circumstances please seek advice. Remember all investments can fall as well as rise in value so investors could get back less than they invest.
Our expert research team provide regular updates on a wide range of funds.