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Fixed Interest

Fixed Interest

These funds invest in bonds, which typically pay a fixed rate of interest and therefore often appeal to income-seeking investors.

Kate Marshall - Investment Analyst
01 July 2017

Bonds have historically appealed to income-seeking investors, given the fixed level of interest they pay. They are also 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.

Most investors gain exposure to bonds via a diversified portfolio of fixed-interest investments, run by an experienced portfolio manager. Funds investing in this asset class have different areas of focus:

  • 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.
  • 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 and 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

In a world of low interest rates and economic uncertainty, investors have continued to seek sanctuary in the bond markets. They have generally performed well in recent years, and as bond prices have risen, yields have fallen, although please remember past performance is not a guide to the future.

There are concerns that rising interest rates will be the catalyst to reverse the fortunes of the bond markets. As interest rates rise, the income available from cash on deposit looks commensurably more attractive than that available from bonds.

The Federal Reserve has started to raise interest rates in the US at a marginal pace, but rates in the UK remain stubbornly low and fixed-income investments remain attractive to yield-starved investors. These markets also continue to be propped up by the bond-buying programmes of the developed world’s major central banks, including the UK, Japan and Europe.

Inflation concerns are also on the rise and this may see a greater willingness for central banks to increase interest rates faster, which would be bad news for bond markets. Interest rates are likely to peak below historic levels, however, given debt remains high and would become difficult to service if rates rose too far, too fast.

With yields already at historically-low levels there is little room for yields to fall further, yet plenty of scope for them to rise. The lower yields get, the more volatility could increase and exposes investors to swings in the value of their capital. A reversal in the bond markets should not be ruled out. That said, while interest rates remain low and economic growth remains subdued, we do not see any immediate catalyst for bond prices to fall and yields to rise.

For now we feel bonds still have their place in a diversified portfolio. With arguably less value on offer in the bond markets, we believe a fully flexible approach is currently a desirable characteristic of funds investing in bonds. We continue to favour strategic and global bond funds, which have the flexibility to seek the best returns from across global bond markets and respond quickly to changes in the investment environment. Some also aim to shelter investors’ capital in the event of turbulent market conditions, which we also view as attractive in the current environment.

Our favourite bond funds currently feature on the Wealth 150 list of our favourite funds. Investors who prefer a professional fund manager to run a diversified portfolio of bond funds on their behalf may wish to consider funds like the HL Multi-Manager Strategic Bond Trust. A defensive approach is currently adopted by the managers and we expect the fund to perform relatively well during tougher times for bond markets, but lag a rapidly-rising market. 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.

Investment notes

Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.

Bond markets across the globe have performed remarkably well over the past decade, although this means yields have fallen in tandem.

Interest rates were slashed to historic lows in the aftermath of the 2008 global financial crisis. Many savers have since foregone the security of cash and invested their capital in riskier assets in their search for a higher income. Bonds have therefore remained popular with investors because of the fixed rate of interest they pay.

Bond markets have also been supported by quantitative easing programmes, in which central banks across the globe have purchased huge swathes of government and corporate bonds; as well as pension funds buying bonds to meet their liabilities.

Over the past year, bond markets have generally continued to perform well, although this has been punctuated with periods of volatility. Higher-risk global high yield bonds and emerging market debt delivered particularly impressive returns as investors continued to favour the relatively higher yields on offer in this low interest rate environment.

With expectations for higher inflation also on the rise, UK inflation-linked government bonds also performed well and outpaced conventional UK government bonds, albeit with greater levels of volatility. UK corporate bonds also delivered an attractive return over the 12 month period. Past performance should not be seen as a guide to future returns.

Against this backdrop, funds with a bias towards high yield bonds were some of the strongest performers over the year. Bond funds investing globally were weaker, as global corporate bonds tended to underperform their UK counterparts, but still managed to deliver a modest total return.

Past performance is not a guide to future returns. Source: Lipper IM, correct at 30/06/2017.

Annual percentage growth
Jun 12 -
Jun 13
Jun 13 -
Jun 14
Jun 14 -
Jun 15
Jun 15 -
Jun 16
Jun 16 -
Jun 17
IA £ Corporate Bond 6.3 6.1 4.3 5.9 6.4
IA £ High Yield 11.0 10.9 -1.2 0.8 10.2
IA £ Strategic Bond 7.0 7.3 2.5 2.9 6.5
IA Global Bond 4.4 -1.2 0 13.5 4.2

In our view, government and corporate bonds continue to serve their purpose as part of a diversified portfolio. They often perform differently to other assets and higher-quality bonds can offer some shelter in tougher times. 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 interest rate environment.

Investment notes

Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.

Five year performance

  • IA £ Corporate Bond

    +32.6%

  • IA £ High Yield

    +35.1%

  • IA £ Strategic Bond

    +29.0%

  • IA Global Bond

    +22.0%

Past performance is not a guide to future returns. Source: Lipper IM, correct at 30/06/2017.

Our favourite funds in the sector

We undertake a comprehensive review of every sector. Here we provide comments on a selection of funds of interest following our most recent Fixed Interest sector review. They are provided for your interest but are not a guide to how you should invest. If you are unsure of the suitability of an investment for your circumstances seek personal advice. Comments are correct as at July 2017.

The majority 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.

To view a full list of our favourite funds within the sector, visit the Wealth 150. There is a tiered charge to hold funds in the Vantage Service with a maximum of 0.45% p.a. - view our charges.

Other funds in the sector

Here we look at some other funds of interest following our most recent sector review. Please note the review period may be over a short time period and past performance is not a guide to future returns.

Source for performance figures: Financial Express

Corporate Bond. This investment grade corporate bond fund is managed by Invesco Perpetual's highly-experienced fixed interest team. The managers build high-conviction positions and the portfolio can look and perform significantly different from the peer group.

The managers’ more cautious stance has held back performance in recent years as bond markets have continued to perform well. However, we recognise even the best fund managers go through periods of lacklustre performance and we believe Paul Causer and Michael Matthews have the ability to deliver excellent long-term returns. Financial bonds, particularly those issued by banks, are currently the managers’ preferred area of opportunity. Over a quarter of the fund is invested in this area, including in bonds issued by Lloyds and Barclays. In anticipation of better opportunities being available at a later date, some of the fund is also invested in cash and bonds that can be sold quickly and easily, such as government bonds.

Corporate Bond. Investment grade corporate bonds are the area of focus for this fund. It has tended to perform well versus its peers in tougher times for bond markets, though may look fairly pedestrian in stronger periods.

The manager has kept the fund’s ‘duration’ relatively short in recent years and this has held back performance. This affords some protection against rising interest rates, although rates have remained stubbornly low and it has therefore been the wrong call to be short duration. That said, the performance of the fund has still managed to keep pace with its peers over the past year. We view Richard Woolnough as one of the most knowledgeable fixed-interest investors in the industry and continue to believe he will do a good job for long-term investors, although please remember past performance is not a guide to the future.

Corporate Bond. This fund is generally more defensive than some other funds in the sector. It may appeal to investors seeking exposure to a more conventional portfolio of investment grade corporate bonds.

Performance has been held back slightly over the past year by the fund’s ‘duration’ being kept relatively short. This affords some protection against rising interest rates, however, in recent years interest rates have stayed lower for longer than expected. That said, this is only over a short period and the fund’s performance has been much better over the longer term, although please remember past performance is not a guide to future returns. Investments in bonds issued by banks and financial companies have performed well recently, and those issued by utilities companies also feature relatively heavily in the fund.

Corporate Bond. This fund aims to track the Markit iBoxx GBP Non-Gilts Overall TR Index, a broad index of around 1,000 investment grade corporate bonds.

The fund provides investors with broad exposure to the UK corporate bond market. This area of the market has delivered good total returns for investors over the past year, although this is not a guide to how the index or fund will perform in future.

Strategic Bond. This is a highly-flexible fund managed by two experienced fund managers. They aim to shelter the portfolio when they see tough times ahead; and seek strong returns as more opportunities become available.

Paul Causer and Paul Read’s more conservative approach has not paid off in recent years as bond markets have performed strongly. However, we have some sympathy with their view that there is little value to be found across bond markets and attractive opportunities are few and far between. We also have faith in them to pounce when better opportunities arise and continue to believe the managers have the potential to deliver excellent long-term performance. Presently around half the fund is invested in government bonds, short-term bonds, and cash. The rest of the portfolio is invested in areas of the corporate bond market where the managers continue to identify value, such as financials.

Strategic Bond. This is a highly-flexible bond fund. Ariel Bezalel seeks to achieve good returns for investors through a combination of income and capital growth and, while he aims to shelter the portfolio during tougher times, this fund can experience greater volatility when the manager is in search of higher returns.

The fund has performed in line with the IA £ Strategic Bond sector average over the past year. Exposure to the financial sector, particularly bonds issued by banks, was beneficial. Investments in higher-risk emerging market debt also contributed positively. Longer-term performance has been exceptional, although this is not a guide to the future. We believe Ariel Bezalel has added value through an astute reading of the economic and bond market environment, plus an ability to identify bonds that have gone on to perform well. He has historically searched off the beaten track for opportunities, in areas overlooked by other investors.

Global Bond. Jim Leaviss has great flexibility to invest across global bond markets and the fund can be heavily exposed to foreign currencies. While the fund does not prioritise a high income we feel it is a great choice to maximise total returns from, and provide diversification to, a UK-focused fixed-interest portfolio.

The fund’s flexible approach to foreign currencies can have a significant impact on its performance. A large exposure to the strengthening US dollar boosted returns over the past year, although it acted as a hindrance in recent months as the greenback weakened against the pound. Around two thirds of the fund is currently invested in global government bonds and cash. The remainder is largely invested in corporate bonds, although exposure was reduced following strong performance last year. The manager continues to find value in bonds issued by US financial companies and banks, and also recently initiated investments in emerging market government bonds, which are higher risk than those issued in developed markets. The fund may also invest more than 35% in securities issued or guaranteed by an EEA state or other countries listed in the fund’s prospectus.

Index-Linked Gilt. This inflation-linked gilt fund is a low-cost way for investors to gain access to inflation-protected gilts, which are issued by the UK government.

UK index-linked gilts have performed well over the past year, although performance has been volatile. The fund has tracked its benchmark index tightly over the 12 month period, as well as over the longer term. A relatively small number of 28 stocks currently feature in the index. The concentrated nature of the fund adds risk as each investment can have a meaningful impact on performance.

Please note charges can be taken from capital which can increase the yield but reduces the potential for capital growth.

Global Bond. This fund offers global exposure to fixed-interest investments and currently has a bias towards the debt of emerging market governments. It could be considered by investors willing to accept higher risk and who believe in the long-term emerging markets story.

An emerging markets bias and higher-risk approach has worked well for the fund over the past year. The fund has significant exposure to Latin America, including countries the manager and his team feel are undergoing a positive turnaround following a difficult few years. This includes Brazil, Argentina and Colombia. We feel this fund has the potential to deliver good long-term performance for investors, however, a combination of the higher-risk approach and relatively high fund charges means we are not currently considering this fund for a place on the Wealth 150.

Please note charges can be taken from capital which can increase the yield but reduce the potential for capital growth. As this is an offshore fund you are not normally entitled to compensation through the UK Financial Services Compensation Scheme.

High Yield Bond. This fund predominantly invests in higher-risk high yield bonds. It may appeal to investors predominantly seeking a high income from their fixed-interest portfolio rather than capital growth, and who are happy to accept higher levels of volatility.

The fund has largely performed in line with the IA £ High Yield Bond sector average over the past year. The managers tend to take a relatively more defensive position than some of their peers, which means the fund can underperform in a stronger environment for high yield bonds, but hold up relatively well in weaker markets. We feel the team at Kames take a sensible approach to high-yield bond investing and believe this fund represents a good choice for investors seeking exposure to this area of the market. That said, in the current environment, we feel it has become increasingly difficult for high yield bond fund managers to add value and, combined with a high fund charge, we feel it has become more difficult for the managers to outperform. The fund can also invest in emerging market bonds, which adds risk.

Please note charges can be taken from capital which can increase the yield but reduces the potential for capital growth.