Bond funds quarterly review – our outlook for the bond market

It’s almost been a year since we saw the impact of the pandemic and lockdowns. It’s tested businesses being able to survive with big hits to revenue and economic growth. In financial markets, there was volatility not seen since the global financial crisis over a decade ago.

In this fixed income quarterly sector review, we look at what's happened to bond markets in recent months and share our outlook for the future. We also take a closer look at how different areas of the bond market have performed, including which funds delivered the best returns.

This article isn’t personal advice. If you're not sure if an investment is right for you, please contact us about advice. Investments rise and fall in value, so you could get back less than you invest.

A look back to 2020

In response to the pandemic, global central banks acted quickly and decisively, expanding their balance sheets to help provide access to more money in the economy. This was particularly helpful for businesses in being able to borrow more money. In the UK, the Bank of England cut interest rates to just 0.1% – the lowest level in its 325-year history.

This support allowed companies to return to the market to raise new money, through new equity or issuing new debt to investors. This helped to shore up their reserves to see them through the tough period ahead.

The economic response wasn’t just focused on interest rates and quantitative easing (monetary policies), but also on lots of government spending (fiscal policies). Politicians around the world have spent over $10trn on essential fiscal support so far. Schemes introduced by governments include furlough schemes to preserve jobs and business support loans and grants.

In this crisis we’ve seen much more co-ordination between central banks and governments, avoiding even worse conditions had this not been the case.

On an individual level, lots of consumer trends have accelerated. Working from home has meant lots of us have been doing our shopping, socialising and learning online. Although this was happening before the pandemic, these trends have been fast-tracked and are likely to have lasting impacts.

What’s the outlook for the bond market?

It’s clear that, for at least a while longer, monetary and fiscal support will be needed. It’s likely central banks and governments will provide this. After all, they should be aware of the danger of reducing their support too soon and risking stalling the recovery just as it’s picking up pace. Investors, companies and policymakers alike will want to see a smooth vaccine roll out and new infection rates falling.

One theme that could be on the minds of investors throughout the year though is the potential for higher inflation. There are arguments on both sides here. On the one hand some argue that the sheer level of stimulus to the economy could lead to higher inflation and will support investment prices the longer it continues.

We’ve also seen disruption to some supply chains from the pandemic recently, pushing the prices of some goods up. Perhaps the clearest sign will be a spike in activity and growth as businesses reopen and consumers spend pent up savings into the economy.

Could an inflation revival change the world of investing?

While this will have the potential to increase inflation, there are arguments against a rise too. Ageing populations, slower long-term increases to wages and high debt burdens all point to inflation heading in the opposite direction.

How should investors respond to a change in inflation?

What are policymakers thinking? Well, the US Federal Reserve has shifted its approach and will target an average inflation rate of 2%, rather than a fixed goal of 2%. This means it’ll tolerate overshoots above this target, but not undershoots. It could be a sign the US economy will be allowed to run ‘hot’ in the post Covid period, supporting the recovery.

With fixed income yields near historic lows and $18trn outstanding in negative yielding debt, we think it’ll continue to be a tricky market for fund managers to navigate.

Bond markets have risen strongly in the last few decades. But as a bond’s price rises, the income you get back as a percentage of the price (yield) falls. With current yields so low, and prices across the board quite high, the chance of significant further gains is unlikely. In fact, we think it’s more likely we could see capital losses.

We don’t think that means they should be ignored completely though, as bonds can be a key part of a diversified portfolio.

As ever, all investments can fall as well as rise in value, so you could get back less than you invest. Investors should hold a well-diversified portfolio and past performance is not a guide to the future. For those who need a little more help, it could be worth getting financial advice.

How have bond funds performed?

Out of all the major bond sectors, Corporate Bond and Strategic Bond delivered the highest returns, both 4.5%*. Corporate bond funds invest at least 80% in higher-quality, investment grade bonds issued by companies. Strategic bond funds have more freedom to invest across bond markets, including government, corporate and high-yield bonds. Both types must invest at least 80% of their assets in bonds that are either denominated in or hedged back to sterling.

Unlike the last quarterly review in November, each of the bond sectors in the chart below delivered a positive return over the past 12 months. The Global Emerging Markets Bond sector delivered the lowest return of the group, with a return of 0.9%.

1 year bond sector performance – total return

Past performance isn’t a guide to the future. Source: *Lipper IM to 31/01/2021.

Past performance isn’t a guide to the future. Source: *Lipper IM to 31/01/2021.

The top performer across all bond sectors over the last year (to 31 January 2021) is Allianz Strategic Bond, co-managed by Mike Riddell and Kacper Brzezniak. The fund grew by 28.1%*, compared with the IA Strategic Bond group’s 4.5%. Although past performance is not a guide to future returns.

In the first quarter of 2020 (January to March), the fund was positioned defensively as the managers believed the market was riskier than prices seemed to suggest. But in the second quarter, the managers took advantage of attractive valuations in new corporate bond issues. This opportunity followed the US Federal Reserve’s increased support through printing money (quantitative easing).

The managers think the global recovery will continue, but will be quite uneven, with Asia in particular expected to deliver strong growth in the months ahead. They see this as being driven by higher demand, which should benefit the emerging markets currencies of commodity exporting countries. As a result, they’ve increased how much they have invested in local currency sovereign bonds in the region.

Annual percentage growth

Past performance is not a guide to the future. Source: *Lipper IM to 31/01/2021.

FIND OUT MORE ABOUT ALLIANZ STRATEGIC BOND INCLUDING CHARGES

ALLIANZ STRATEGIC BOND KEY INVESTOR INFORMATION

What have the research team been doing?

We spoke to Jim Leaviss and Eva Sun Wai, lead manager and deputy manager of the M&G Global Macro Bond fund. We spoke about how the portfolio had changed shape over the past year and which parts of the market are most attractively valued at the moment. We also discussed Sun Wai’s increased responsibilities since replacing Claudia Calich as deputy manager, as well as her investment philosophy.

We had a virtual meeting with Paul Causer and Stuart Edwards, co-managers of the Invesco Tactical Bond fund. The managers aim to provide some income and capital growth over the long term. They combine their analysis of the economy and individual bonds to shape the portfolio, and can invest in all types of bonds with very few constraints placed on them. The fund also delivered the highest return of our fixed income Wealth Shortlist selections.

We also spoke to the fixed income team at BlackRock to get an update on the iShares Corporate Bond Index fund. It offers a simple way to invest broadly across the UK corporate bond market, investing in just under 1,200 bonds currently. We think BlackRock has the scale and experience to track indices efficiently, which should help to reduce trading costs.

How have our Wealth Shortlist funds performed?

Our Wealth Shortlist selections have delivered a mixed bag of performance over the past year. We wouldn’t expect them all to perform in the same way. If all your funds in a sector are performing well at the same time, they're probably investing in similar areas. That's great when those areas are in favour but can be painful when they're not.

It’s important for investors to build a portfolio filled with managers who have different approaches and investing styles. Doing this should better investors’ chances of performing well over the long run although of course there are no guarantees.

The best performing Wealth Shortlist fixed income fund over the last year was the Invesco Tactical Bond fund, which sits in the IA Strategic Bond sector. The fund grew 12.1%*, beating the peer group average by 7.6%. Past performance isn’t a guide to the future. It’s now co-managed by Stuart Edwards, Jack Parker and the experienced Paul Causer, after Paul Read stepped back from the fund last year.

The fund performed particularly well when coronavirus initially hit markets over March and April 2020. The managers had been cautious on the outlook for bonds for some time and as a result, had positioned the fund defensively. This meant having more invested in government bonds and cash, which meant the fund held up better than lots of its peers as markets fell.

The weakest performer was Artemis High Income. The fund’s managed by Alex Ralph who focuses on higher yielding bonds to generate a higher income for investors. These higher-risk bonds are usually issued by less-creditworthy companies. At the time of writing, the fund yields 4.7% (variable and not a reliable guide to future income).

These lower quality bonds didn’t hold up as well as other higher-quality bonds when coronavirus hit markets. This isn’t surprising though because companies with a lower credit rating are generally less likely to be able to repay their debts than companies rated a higher grade.

The fund gained 1.3% over the year and finished 3.2% behind the strategic bond peer group average. Ralph has the flexibility to invest up to 20% of the fund in UK and European shares to help boost the fund’s yield. This means she can change how the fund’s invested, depending on her views on the wider economy and the state of bond markets. She’s an experienced fund manager and has a good long-term track record of delivering for investors.

As the Artemis Corporate Bond fund was launched in October 2019, it’s only possible to provide one year of annual performance data.

Here’s how our Wealth Shortlist funds have done. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

Strategic Bond – annual percentage growth

Global Bond – annual percentage growth

Corporate Bond – annual percentage growth

Past performance isn’t a guide to the future. Source: *Lipper IM to 31/01/2021.

n/a – Full year data unavailable.

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FIND OUT MORE ABOUT ARTEMIS CORPORATE BOND INCLUDING CHARGES

ARTEMIS CORPORATE BOND KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT ARTEMIS HIGH INCOME INCLUDING CHARGES

ARTEMIS HIGH INCOME KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT ARTEMIS STRATEGIC BOND INCLUDING CHARGES

ARTEMIS STRATEGIC BOND KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT FIDELITY MONEYBUILDER INCOME INCLUDING CHARGES

FIDELITY MONEYBUILDER INCOME KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT INVESCO TACTICAL BOND INCLUDING CHARGES

INVESCO TACTICAL BOND KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT iShares Corporate Bond index INCLUDING CHARGES

iShares Corporate Bond index KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT JUPITER STRATEGIC BOND INCLUDING CHARGES

JUPITER STRATEGIC BOND KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT Legal & General All Stocks Gilt Index INCLUDING CHARGES

Legal & General All Stocks Gilt Index KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT M&G GLOBAL MACRO BOND INCLUDING CHARGES

M&G GLOBAL MACRO BOND KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT MORGAN STANLEY STERLING CORPORATE BOND INCLUDING CHARGES

MORGAN STANLEY STERLING CORPORATE BOND KEY INVESTOR INFORMATION

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FIND OUT MORE ABOUT ROYAL LONDON CORPORATE BOND INCLUDING CHARGES

ROYAL LONDON CORPORATE BOND KEY INVESTOR INFORMATION

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