Bond funds sector review – a devastating quarter for bond investors

Bonds continued their downward spiral over the last quarter, with the UK market in particular impacted by the, now defunct, ‘mini-budget’ in late September. The losses have been extreme, particularly for an asset class that’s supposed to offer s­ome stability to investors’ portfolios.

What’s the latest on interest rates and inflation in the UK?

Inflation remains stubbornly high, sitting at 10.1% in September. The introduction of the energy price guarantee, which is designed to keep the cost of the average household annual energy bill at around £2,500, has helped stop this rising further. However, that hasn’t helped businesses, where the only way to try and survive has been to increase prices.

This has caused the Bank of England (BoE) to continue to raise interest rates, with the latest rise of 0.75% being the biggest increase in 30 years. This takes the current base rate to 3%, the highest it’s been since 2008. Interest rate increases haven’t only been in the UK though. The US Federal Reserve and European Central Bank also increased their rates by 0.75% recently.

There’s still debate about where inflation and interest rates go from here. Many feel inflation will begin to fall in 2023, not least the BoE, but when and by how much remains unknown. The same can be said about interest rates. Most expect these to peak at some point in 2023. But the level of the peaks and how long rates will have to stay there to tame inflation are also unknowns.

The only thing that’s almost certain is the UK going into recession in 2023. The BoE’s latest view is that recession is coming, with potential for it to be the longest recession since the second world war. How bad it is depends on how high interest rates have to go to bring inflation back under control.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, please ask for financial advice.

What’s happening in the bond market?

The combined impact of inflation, interest rate rises, and the expectations of recession has been devastating for bonds. Sector average performance over the quarter for the IA UK Gilts, IA £ Strategic Bond and IA £ Corporate Bond sectors were -11.48%, -5.98% and -8.96% respectively.

To put those falls into context, we looked at how often these sector averages have lost more than 5% in any three-month period from the end of 2001 to the end of 2021. The IA UK Gilts, IA £ Strategic Bond and IA £ Corporate Bond sector averages only had five, four and three such periods respectively. The number of three-month periods included in that analysis is 239.

What bond investors have experienced in the last quarter, and throughout 2022, is rare in recent history.

Just because it has been rare historically, doesn’t mean it won’t happen again, given the environment of continuing high inflation and interest rate rises noted earlier though.

As a result of these losses and rising interest rates, bond yields have increased significantly throughout 2022 and that trend continued during the last quarter. The UK 10-year gilt yield increased from 1.84% at the start of August to 3.7% at the end of October. Other bond yields have increased by similar proportions. Bond yields aren’t a guarantee of future income though, they’re just a snapshot at a point in time.

With the yields now on offer, bonds look more attractive in terms of the income they offer going forward than they have done over the last few years. Of course, nothing is guaranteed.

For investors who require income and have a longer-term horizon (at least five years), the outlook for investing in bonds is likely better than it has been for some time. However, the potential for further price falls and volatility remains, particularly over the short term. Remember, past performance isn’t a guide to future returns.

How have our fixed income Wealth Shortlist funds performed?

Our Wealth Shortlist bond picks 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. Remember, 12 months is a short timeframe when looking at how an investment has performed. Past performance isn’t a guide to the future.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

The best performing Wealth Shortlist fixed income fund over the last year was M&G Global Macro Bond, with a return of -4.35%*.

Jim Leaviss and Eva Sun-Wai start with a 'bigger picture' macroeconomic outlook. This includes forming a view on economic growth, interest rates and inflation globally. This then helps them decide how much to invest in different areas of the bond market and different currencies.

Leaviss has historically used the flexibility afforded to him in the fund to good effect to deliver strong returns for investors. We believe experience is vital for a manager of this type of fund and Leaviss is one of the most experienced bond fund managers in the UK.

The fund’s exposure to US dollars has helped performance over the last quarter. The managers have been defensively positioned, due to concerns around inflation and rate rises, and this has also helped to keep losses lower than their peers. But the bonds they hold have still lost value.

MORE ABOUT M&G GLOBAL MACRO BOND, INCLUDING CHARGES

M&G GLOBAL MACRO BOND KEY INVESTOR INFORMATION

The worst-performing Wealth Shortlist fixed income fund over the last 12 months was the Legal & General All Stocks Gilt index, returning -21.67%* over the period.

The fund offers a simple way to invest in UK government bonds across all maturities. It can help diversify a portfolio focused on shares or other types of investment. Inflation and rate rises have resulted in the fund losing money over the period. As this is a passive fund, performance isn’t due to the decisions of the manager.

MORE ABOUT LEGAL & GENERAL ALL STOCKS GILT INDEX INCLUDING CHARGES

LEGAL & GENERAL ALL STOCKS GILT INDEX KEY INVESTOR INFORMATION

Past performance isn’t a guide to the future. Source: *Lipper IM, to 31/10/2022.

Past performance isn’t a guide to the future. Source: *Lipper IM, to 31/10/2022.

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Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.