Bond funds sector review – multiple headwinds drive yields upwards

Bond investors haven’t had it easy recently. Corporate bonds (issued by companies) and government bonds have suffered amid a hostile inflationary environment.

Spiralling inflation, rising interest rates, faltering economic growth and slumping consumer confidence are the issues of the day, all posing unwelcome headwinds.

What’s the latest on interest rates and inflation?

In the UK, inflation rose 9% in the year to April – the fastest in 40 years, and is expected to reach double figures in the coming months.

This is a problem for the central bank who has a 2% inflation target. In May, it announced a fourth consecutive rate rise, increasing interest rates another 0.25% to 1%. However, this is still low by historical standards.

Higher energy, fuel and food prices are raising the cost of living to uncomfortable levels for many. Spending on these essentials reduces consumers disposable income, leaving them with less to spend on other ‘nice to have’ goods and services.

The issue for Bank of England (BoE) Governor, Andrew Bailey, is that a significant portion of the inflation drivers are global in nature. So, although the bank might try to cool inflation by raising interest rates, global price rises for energy and food are largely out of its control.

What is happening in the bond market?

The level of inflation we’re seeing is putting pressure on central banks to be more aggressive in their approach to raising interest rates. In April, we saw government bonds sell off across the board, with US treasuries and UK gilts both shedding more than 3% of their value. Higher quality corporate bonds, which tend to be more sensitive to interest rates, also suffered.

High inflation is normally bad news for bonds as the spending power of the fixed income holders receive is eroded. This limits how well investors can shelter themselves from falling share prices as bonds usually offer some respite when stock markets stumble.

Over the longer term, there’s some optimism that the rising yields and falling bond valuations we’ve seen, leaves some areas of the market offering more value than before.

Looking ahead, it’s unlikely that the volatility we’ve seen in bond markets will recede anytime soon. Higher interest rates can help keep prices in check by encouraging people to save more and therefore spend less in the economy, dampening demand for goods and services. As a result, the probability of a recession increases.

Central banks are well aware of this and are walking a tightrope between tackling inflation and avoiding a recession.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, please ask for financial advice. All investments and any income they produce can rise as well as fall in value, so you could get back less than you put in. Past performance also 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. All funds have fallen in value though, against a backdrop of falling bond prices. 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.

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. Both funds invest in high-yield bonds which are higher risk.

The best performing Wealth Shortlist fixed income fund over the last year was M&G Global Macro Bond with a return of -2.16%*.

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.

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 year was the Vanguard Global Corporate Bond Index.

The fund provides broad exposure to global corporate bonds and aims to track the Bloomberg Barclays Global Aggregate Corporate Index. The team use partial replication to track the index and use currency hedging to convert overseas currency bonds back to sterling.

Given Vanguard’s size, experience and expertise, we expect the fund to continue to track the benchmark well in the future, though there are no guarantees.

More about Vanguard Global Corporate Bond Index, Including charges

Vanguard Global Corporate Bond Index Key Investor Information

Annual percentage growth (%)

Past performance is not a guide to the future. Source: *Lipper IM, to 30/04/2022.

Annual percentage growth (%)

Past performance is not a guide to the future. Source: *Lipper IM, to 30/04/2022.

N/A means performance data for this period isn’t available.

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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.