Investors can get exposure to bonds through funds run by a portfolio manager, but there are several different types of bond funds:
- Corporate bond funds – focus on higher-quality, investment grade bonds issued by companies. Compared to high yield bonds they have a lower risk of default and are more likely to be able to repay their debts. 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 extra risk taken, because these bonds are issued by companies that are less likely to be able to pay off their debts.
- Strategic bond funds – have the freedom to invest across the bond markets, including government, corporate and high-yield bonds. They also have some flexibility to invest overseas. Some focus more on paying a high income. Others focus more on growing or sheltering investors' wealth.
- Global bond funds – invest in government and corporate bonds issued globally. They also hold bonds denominated in currencies other than sterling. This means they might have a lot of exposure to foreign currencies. Similar to strategic bond funds, their objectives vary from fund to fund.
- Gilt and index-linked gilt funds – mainly invest in bonds issued by the UK government. They typically have a lower risk of default and lower yields than corporate bonds. Index-linked gilts typically increase any income paid, and the capital repaid at redemption, in line with inflation.
Our view on the Bonds sector
Bonds usually pay a fixed rate of interest. So they can be useful to generate an income.
They're often viewed as ‘lower risk’ than investing in a company’s shares. This means they can help limit some of the volatility that normally comes with investing purely in the stock market.
We believe bonds can play a part in a diversified portfolio. But a number of risks have built up that investors should be aware of.
Bond markets have performed well over recent years, but as a bond’s price rises its yield falls. And given the low level yields are now at, the scope for significant further gains is limited and the income on offer has reduced. This means there's lower potential rewards on offer for taking on the risks of lending to companies and governments. There's also more room for yields to rise and prices to fall. So investors could see more volatility in this area of the market than they've been used to in recent years. It 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 slowdown in economic growth that makes it harder for companies to pay 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).
That’s not to say bonds should be ignored completely. They still have the potential to perform well and have provided some shelter over the past year during times when share prices have faltered. This highlights the benefits they can potentially bring to a diversified portfolio. While we don’t think interest rates will rise quickly in the short term, it’s important investors are aware of the risks associated with investing in bonds.
Our favourite bond funds feature on the Wealth 50. We currently prefer strategic bond funds because they have the flexibility to try and make returns from all areas of the bond markets.
Investors who prefer a professional fund manager to run a diversified portfolio of bond funds for them could look at the HL Multi-Manager Strategic Bond Trust. We think the additional costs of a multi-manager fund are justified by the extra layer of oversight from experienced investors. The HL Multi-Manager funds are managed by our sister company HL Fund Managers.
2019 was a good year for bond markets.
Bonds have traditionally been a natural hunting ground for income seeking investors, largely due to the fixed level of interest they pay and their ability to offer a shelter against falling share prices. And falling interest rates has meant that the value of many of these bonds have risen. So investors who’ve bought bonds when rates have been falling will have received the benefit of both the income they have provided as well as the capital gain. But as bond prices rise, their yields fall. The 10-year gilt yield, which represents lending money to the UK government for 10 years, stands at just 0.55%, which when considering the eroding effects of inflation, effectively offers a negative real yield to investors.
The Federal Reserve in the United States dropped interest rates three times in 2019 to combat the economic slowdown, marking a reversal of its previous attempts to move rates in the opposite direction. Lower rates make borrowing more attractive for businesses, offering them cheaper cash for investment. And businesses have taken full advantage, with corporate debt levels reaching record highs in 2019. Quantitative easing (QE) programmes around the world have also seen central banks, like the European Central Bank (ECB) and the Bank of England (BOE) buying up huge amounts of government and corporate bonds, while pension funds have also been buying bonds to meet their liabilities, supporting markets further.
But monetary policy can only go so far, interest rates are at all-time lows and can only really rise from here. Fed Chairman Jerome Powell reinforced this by making it clear they have no further rate cuts planned in the US, unless economic data deteriorates significantly. And if and when interest rates do rise in the future, it would mean higher yields but it could expose investors to higher volatility and the potential for capital loss.
Bond Market – Annual Performance 2019
Past performance is not a guide to the future. Source: Lipper IM to 31/12/2019
Higher-risk high yield bonds delivered the best returns over the year out of all of the major Investment Association (IA) bond sectors with an annual return of 11.5%. High-yield bonds tend to offer investors a higher rate of interest because the companies issuing the debt are seen as being less financially secure. Additionally when interest rates are low it’s more likely these companies will be able to repay their debts, due to the relatively lower nature of interest payments. All other major bonds sectors also provided investors with positive returns over the year. We feel bonds still have an important place in a well-diversified portfolio. They could provide an element of shelter during more turbulent times for economies or global markets, and could limit the volatility that comes with other higher risk investments like shares.
Our favourite funds in the sector
For more information, please refer to the Key Investor Information Document for the specific fund risks. 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 this sector
Here we look at some other funds of interest following our most recent sector review. Please note the review may be over a short time period and past performance is not a guide to future returns.
Source for performance figures: Financial Express
The fund mainly invests in investment grade corporate bonds. The managers, Paul Causer and Michael Matthews, are prepared to be flexible and invest the fund differently to other corporate bond funds. This can mean performance has the potential to look quite different and the fund can be higher risk.
The managers actively shift how much risk they take according to their view of the world, so it’s a flexible approach. They’ve taken a fairly cautious approach in recent years as they thought the environment for bonds was going to get tougher. But inflation remaining low and central banks restarting their support for the markets meant this hasn’t been the case, holding back returns a little recently. But over the long term, the fund has performed well and delivered greater returns than the broader corporate bond sector. Please note the fund can invest in high-yield bonds and derivatives, which increase risk.
The fund has the freedom to invest across the bond market, allowing Ariel Bezalel to take more risk when the outlook is good, but be more conservative when he’s feeling more cautious. The manager analyses the state of the economy, building up a picture of how he thinks things will develop and then uses this to help him decide where to invest. The fund can invest in emerging market bonds which adds risk.
He’s a talented and experienced manager who’s calls on the economic outlook and ability to select successful bonds within certain sectors has added value for investors over the long term. Although, please remember past performance isn’t a guide to the future. At least 70% of the fund will be invested in bonds bought and sold in British pounds or hedged back to Sterling. The fund can invest in high-yield bonds and derivatives, which increase risk.
The fund aims to shelter investor’s wealth from the effects of inflation (Consumer Price Index) over time rather than trying to grow it significantly. It invests in a range of short dated index linked government and corporate bonds and can use derivatives to add corporate bond exposure to the fund.
We think the manager Ben Lord has done a decent job and the fund’s a good option to achieve an inflation-like return in the long run, though there are no guarantees. He thinks short-dated index-linked government and corporate bonds are a good way to shelter against inflation because these bonds mature sooner than longer-dated bonds. This means they’re less affected by changes in inflation and interest rates so have the potential to offer an inflation-like return, but with less volatility. Please note the fund can invest in derivatives, which add risk. The fund may invest more than 35% in securities issued or guaranteed by a member state of the European Economic Area or other countries listed in the fund’s Prospectus.
This is a very flexible bond fund managed by two experienced fund managers. They aim to shelter the fund when they see tough times ahead, and provide stronger returns when the outlook is better.
The managers have invested this fund in a way that means it could hold up relatively well if bond markets run into trouble. The fund is positioned relatively conservatively with a lot of short-dated government bonds and cash. These kind of bonds can usually be sold fairly quickly meaning the managers can invest in other areas of the market that could provide a stronger return when market conditions look better. The financial sector remains the largest sector in the fund.
This cautious approach has held back performance in recent years because bonds markets have generally performed well. But we think it could provide some shelter when markets are weaker. Please note the fund can invest in high-yield bonds and derivatives, which increase risk.
The fund’s manager Jim Leaviss has the flexibility to invest across global bond markets and currencies and we think he has the experience and resources to do an excellent job for investors. The fund isn’t focused on providing a high income like some other bond funds, but it could offer useful diversification.
Leaviss starts by building his outlook for economic growth, interest rates and inflation across the globe and proactively adjusts the portfolio in response to changing economic conditions. This helps him decide how much to invest in different areas of the bond market. Recently, he’s reduced the fund's exposure to US Treasuries and raised its allocation to Japanese government bonds.
The fund has performed well over the long term and has delivered returns ahead of the broader global bond sector, although past performance isn’t a guide to the future.
This fund can invest in emerging market bonds, high yield bonds and derivatives, which increase risk. The fund may invest more than 35% in securities issued or guaranteed by a member state of the European Economic Area or other countries listed in the fund’s Prospectus.
The fund aims to track the performance of the broader market of UK gilts and provides exposure to a range of gilts at a low cost. This is made up of a range of UK government bonds that are due to be repaid to bondholders over the short, medium and long-term.
Gilts are typically viewed as lower risk because it's unlikely the UK government would default on its debts and be unable to pay the interest due to bondholders. This area of the market has provided a positive return to investors over the last five years, and could offer some conservative diversification to a portfolio. Past performance is not an indication to how the fund or index will perform in the future. Charges for this fund can be taken from the capital rather than the income created which can increase the yield but reduce the potential for capital growth.
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.