Bond funds quarterly review – what could be next for bonds?

It’s been a bumpy few months for bond markets, marked by some sharp yield curve moves. With a more positive outlook for global growth this year, bond markets have been digesting the outlook for inflation, and in turn what this could mean for interest rates.

In this fixed income quarterly sector review, we look at how different areas of the bond market are performing and share our outlook for the bond market. We also look at how some of our Wealth Shortlist funds have fared.

This article isn’t personal advice. If you're not sure if an investment is right for you, please contact us about advice.

A vaccine success story

The UK’s vaccination programme continues to be one of the most successful in the world. At the time of writing, almost two thirds of the adult population have received a first dose. Just under one third have been fully vaccinated – an effort the whole country can be proud of.

This is not only positive news from a health perspective, but from an economic one too. It means we should be able to ease restrictions and resume our usual day-to-day activities over the coming months.

As the prospect of a full reopening of the economy comes closer, the level of pent up demand is being talked about more. This is what economists describe as the prospect of a big increase in consumer demand after a period of subdued spending. And of course, it makes sense. Lots of us haven’t been able to eat out, go to the cinema or see a show in a theatre for some time. And when we’re allowed to, we could even go more than we did pre-pandemic to make up for what we’ve missed out on.

So it’s likely we can expect a fairly significant rebound in demand towards the end of 2021, given that lots of households will likely be in a stronger financial position. This won’t be the same for everybody though. Those who’ve lost their jobs or seen their income cut by being on furlough might not have been able to build their savings as much, if at all.

Rising Bond Yields

A wave of higher demand could provide a tailwind for growth in the economy.

In 2020 the world economy shrank by an estimated 3.5%, with the UK’s gross domestic product (GDP) falling 9.8% – its biggest ever yearly fall. So governments will be hoping for a big rebound to close the gap and kick start the recovery.

When we see a big pick-up in demand, we also need to think about what that could mean for inflation, specifically how high it could rise and how long this will last for. Central banks will be keeping a close eye on it too. If it’s temporary and falls again after an initial rise, they could be willing to look past it. But if inflation sticks around for a while and stays above the Bank of England’s 2% target, they might need to raise interest rates to try and curb it.

Read the views of two bond experts on the outlook for inflation

An expectation of higher inflation to come, combined with a brighter outlook for the economy for the months ahead has been reflected in the gilt (government bond) market. We’ve seen a sustained rise in the 10 year UK government bond yield so far this year. The yield hit 0.91% at the end of April.

Although this is still low by historical standards, it’s a significant rise from its low of 0.12% in August 2020. In this context, the yield represents what you’d earn for lending money to the UK government for the next 10 years.

10 year UK government bond yield

Scroll across to see the full chart.

Past performance isn’t a guide to future returns. Source: Bank of England, to 30/04/2021.

As a bond’s yield rises its price falls, so it’s been a tough few months for some bond funds. While bonds and shares have tended to perform differently in the past, this relationship hasn’t always held true and might not always continue. If low yields suggest bonds look expensive, this could mean they have less potential to offer positive returns when shares suffer losses.

That said, we think bonds have their place as part of a diversified portfolio. Investing in bonds should still help to shelter a portfolio and help reduce the overall ups and downs, compared to only investing in one asset class such as shares.

What the research team have been up to

We recently spoke with Ariel Bezalel, manager of Jupiter Strategic Bond. The fund has a flexible approach which means its performance can be different to others, but we think Bezalel has the skills and experience to reward investors over a longer time horizon. The sharp jump in government bond yields in early 2021 hurt the fund, but Bezalel believes the sell off could be done for now. He thinks that fears of persistently higher inflation are probably misplaced and that factors like demographics, technology, and levels of debt will continue to contain it.

We held a virtual meeting with Stephen Snowden, manager of Artemis Corporate Bond, and his co-manager Grace Le. Since the fund’s launch in October 2019, Snowden and his team have already navigated major events like a UK general election, and the numerous twists and turns in credit markets caused by the pandemic. While the fund’s track record is short, Snowden is a seasoned corporate bond investor, with over 20 years' experience running similar strategies at Old Mutual and Kames.

We also spoke with Nelson Nery, manager of Legal & General All Stocks Gilt Index. The fund aims to track the performance of the UK Gilt market as measured by the FTSE Actuaries UK Gilts All Stocks Index. Legal & General has been running index tracker funds longer than most, with a record spanning more than 30 years. It's one of the largest providers of tracker funds and is home to the biggest index tracker team in the UK. That means it's got the resources and expertise to track indices as closely as possible, and the scale to keep charges to a minimum.

For more details on each fund and its risks, please see the links to their factsheets and key investor information below. Remember past performance is not a guide to the future. Investments and any income they produce can rise as well as fall in value, so you could get back less than you put in.

How have our fixed income Wealth Shortlist funds performed?

Our Wealth Shortlist selections have delivered mixed performance over the past year. Some have outperformed their peer group, and others have underperformed. We wouldn’t expect them all to perform in the same way though. If all your funds in a sector are performing well at the same time, they're probably investing in similar areas.

We think 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.

The best-performing Wealth Shortlist fixed income fund over the last year was Artemis High Income, which sits in the IA Strategic Bond sector. The fund, which has delivered an annual return of 17.4%*, is mainly managed by Alex Ralph, with Ed Legget managing the portion of the fund (up to 20%) invested in the shares of UK and European companies.

Once central banks intervened in markets after coronavirus hit, Ralph took the opportunity to invest more in high yield bonds, that come with more risk. As the year progressed, she also increased the fund’s investment in the shares of cyclical companies that rely on a strong economy to do well.

The worst-performing Wealth Shortlist fund in these sectors was M&G Global Macro Bond which returned -4.5%. The fund has had less credit risk than some others. That means it hasn’t risen as much as other bond funds during the rally from the coronavirus induced lows.

The fund’s reliance on the US Dollar doing well was also a headwind in the second half of 2020. This is a very short time period though. Manager Jim Leaviss is a vastly experienced bond investor with a strong track record. We think his fund has the potential to do well over the long term.

Past performance isn’t a guide to the future. Source: *Lipper IM, to 30/04/2021.

FIND OUT MORE ABOUT ARTEMIS HIGH INCOME INCLUDING CHARGES

ARTEMIS HIGH INCOME KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT JUPITER STRATEGIC BOND INCLUDING CHARGES

JUPITER STRATEGIC BOND KEY INVESTOR INFORMATION

Past performance isn’t a guide to the future. Source: *Lipper IM, to 30/04/2021.

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

M&G GLOBAL MACRO BOND KEY INVESTOR INFORMATION

Past performance isn’t a guide to the future. Source: *Lipper IM, to 30/04/2021.

n/a – Full year data unavailable.

FIND OUT MORE ABOUT ARTEMIS CORPORATE BOND INCLUDING CHARGES

ARTEMIS CORPORATE BOND KEY INVESTOR INFORMATION

FIND OUT MORE ABOUT LEGAL & GENERAL ALL STOCKS GILT INDEX INCLUDING CHARGES

LEGAL & GENERAL ALL STOCKS GILT INDEX KEY INVESTOR INFORMATION

---

Editor’s choice: our weekly email

Sign up to receive the week’s top investment stories from Hargreaves Lansdown