Most investors get exposure to bonds through 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 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 funds – mainly 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
Bonds usually pay a fixed rate of interest. So they appeal to investors seeking a regular 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 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. So the scope for significant further gains is limited and the income on offer has reduced. There's lower potential reward on offer for taking on the risks of lending to companies and governments. And there's more room for yields to rise and prices to fall. This means 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).
We don’t see a major change in fortunes right now. But the risks are worth keeping in mind. Especially by those who invest in bonds to get an attractive income and reduce volatility.
Our favourite bond funds feature on the Wealth 150+ 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 this approach.
The HL Multi-Manager funds are managed by our sister company HL Fund Managers.
Global bond markets have been volatile over the year to 30 June 2018. Especially at the start of 2018 because investors became concerned about inflation and rising interest rates. This would make the income paid by bonds less attractive than the interest paid on cash deposits, for example.
The prices of some higher-risk bonds, such as emerging markets and high yield bonds, were more volatile. Concerns about inflation meant index-linked UK government bonds performed better than conventional UK government bonds and bonds issued by UK companies.
Funds focused on high yield bonds performed best over the year, but only slightly better than corporate and strategic bond funds. Global bond funds lost money, partly because of the strength of the British pound against the US dollar (the global bond market contains a lot of US dollar-denominated bonds).
Bond sectors - one year performance
Past performance is not a guide to future returns. Source: Lipper IM, correct at 30/06/2018.
Global bond markets have performed very well over the longer term. Especially over the past decade although there are no guarantees this will continue.
This is because a combination of low interest rates and quantitative easing have pushed bond yields down to historically low levels. When yields fall bond prices rise. So in recent years investors have made healthy gains, as well as income, from bond investments. This isn't a guide to future returns though.
If the economic outlook gets worse, interest rates could stay lower for longer. This means bonds could remain popular with investors and could keep prices higher. But if inflation or interest rates rise, there could be periods of volatility.
|Annual percentage growth|
| June 12 -
| June 13 -
| June 14 -
| June 15 -
| June 16 -
|IA £ Corporate Bond||6.1%||4.3%||5.9%||6.4%||0.6%|
|IA £ High Yield||10.9%||-1.2%||0.8%||10.2%||0.9%|
|IA £ Strategic Bond||7.3%||2.5%||2.9%||6.5%||0.3%|
|IA Global Bond||-1.2%||0.0||13.5%||4.3%||-0.5%|
Our favourite funds in the sector
These funds can 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.
Source for performance figures: Financial Express
Corporate Bond. This fund mainly invests in investment grade corporate bonds. The managers are prepared to be flexible and invest the fund differently to other corporate bond funds. This means performance can look quite different and the fund can be higher risk.
The managers are currently more cautious in their outlook for bond markets. They've kept the fund's 'duration' relatively short and this has helped performance over the past year. This typically provides some shelter when interest rates rise, or are expected to rise, because short-duration bonds don't fall as far when rates rise. The managers currently like financial bonds, including those issued by banks, because they pay a reasonable amount of income. Current investments include bonds issued by Lloyds and Barclays.
Corporate Bond. The managers are conservative when it comes to bond investing. We view this as a more conventional investment grade corporate bond fund.
The managers currently favour bonds in the financial sector. This includes bonds issued by banks and insurance firms, such as Lloyds, Santander and HSBC. Investments in financial companies recently helped performance, but the fund performed the same as the average fund in the sector over the past year. Longer-term performance is impressive. The fund has done better than the sector over the long run. This isn't a guide to future performance though.
Corporate Bond. Investment grade corporate bonds are mainly held in this fund. It's tended to perform better than similar funds when bond markets are weaker, but perform in a similar way when markets are stronger.
The manager is prepared to invest in some areas other investors have overlooked. This includes asset-backed bonds, where the investor has a claim on the cash flows made by the underlying company. These investments have helped performance recently, although the fund has performed similarly to the average fund in the Corporate Bond sector over the past year. Richard Woolnough is a highly experienced bond investor and he also has the support of a large research team. We'd expect the fund to perform well over the long run, though there's no guarantees.
Strategic Bond. This is a very flexible bond fund managed by two experienced fund managers. They aim to provide some shelter to your investment when they see tough times ahead, and 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. They hold plenty of cash and bonds that can be sold quickly, for example. It also means they can invest in other areas of the market that could provide a stronger return when market conditions look better. The rest of the fund is focused on areas such as financial corporate bonds. The managers think banks are in a much stronger position since the 2008 financial crisis.
Global Bond. Jim Leaviss has a lot of flexibility. He invests across global bond markets and currencies. The fund isn’t focused on providing a high income like some other bond funds, but it offers useful diversification to a UK-focused bond portfolio.
The manager recently increased exposure to the US dollar and Japanese yen. These are typically viewed as safer currencies during periods of uncertainty. This has helped performance so far this year as the US dollar has strengthened against sterling. On the other hand, he doesn't think higher-risk, higher-yield corporate bonds offer as much value. They've performed well for a number of years, though past performance is not a guide to the future. He no longer thinks investors are getting paid enough in the way of income for the level of risk taken. In fact, the fund is now invested in a way that means it could benefit if the prices of high yield bonds fall.
Strategic Bond. Ariel Bezalel makes full use of the flexibility given to him with this fund. He'll change the way it's invested quickly, depending on his views of the wider economy and bond markets.
The manager is more cautious than he's been in the past. So the fund has more invested in government bonds. These are expected to hold up better than bonds issued by companies if bond markets run into trouble. He's invested one quarter of the fund in US government bonds, and around 10% in Australian government bonds. He also invests in some bonds issued by companies, but has focused on those that are financially strong and make enough cash to keep paying off their debts. This includes tech firm Apple and consumer goods company Procter & Gamble. He thinks these are more likely to provide some shelter in a weaker environment.
Corporate Bond. This fund aims to track the performance of the Markit iBoxx GBP Non-Gilts Overall TR Index. This is 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 grown by a small amount over the past year, though this is not a guide to how the index or fund will perform in future.
Index-Linked Gilt. This fund provides a low-cost way to invest in a number of inflation-protected gilts. These are issued and backed by the UK government.
UK index-linked gilts have performed better than conventional UK government bonds, but performance has been more volatile. The fund aims to track the performance of the FTSE Actuaries UK Index Linked Gilt All Stocks Index – it's tracked this benchmark tightly over both the short and the longer term.
Please note charges can be taken from capital which can increase the yield but reduces 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.