Bond funds sector review – volatile times for bonds

Bond investors have had a rocky ride over the last quarter, continuing the challenging journey so far this year.

Inflation continues to rise, causing an uncomfortable cost of living squeeze for many. The result has been rising interest rates and it’s now expected that the UK will go into recession towards the end of 2022.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, please ask for financial advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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

In the UK, inflation hit 10.1% in the year to August, and it’s expected to rise further.

This is significantly above the Bank of England’s target inflation rate of 2%. As a result, interest rates have risen, from 1% in May to 1.75% now. This is still low by historical standards, though more rate rises are expected before the end of the year.

High inflation is normally bad news for bonds as the real returns achieved are reduced because most bonds pay fixed returns. Plus, bond values tend to fall as interest rates rise because people can earn more from keeping their cash in savings accounts. While prices are increasing across the board, it’s food and energy price rises that are hurting the most. A recent high-profile example is McDonalds increasing the price of its cheeseburger from £0.99 to £1.19 – a rise of 20%. The last time they increased the price of a cheeseburger was 14 years ago.

Energy prices have also risen significantly, which is expected to put more strain on consumers when the energy price cap takes effect in October. Even with government support measures, this will result in less money for people to spend on goods and services.

As many of the drivers for these price rises are global in nature (inflation in the Euro area is currently 8.9% and in the US it’s 8.5%), it’s difficult for the UK to combat this on its own.

What’s happening in the bond market?

From the start of May to mid-June, bonds sold off across the board, largely in part because of the US Federal Reserve (FED) increasing interest rates at a quicker pace than had previously been expected.

Since then, bonds have rallied. With investors hopeful that, although there are more to come, the bulk of these rate rises have now been implemented.

As a result, most bond values at the end of July are only down a little bit from where they were at the end of April, although the journey’s been a volatile one.

The bigger concern now is recession. A recession is when the economy shrinks in size for two consecutive quarters.

As the economy gets smaller, businesses often make less profit, and the government receives fewer taxes. This can make it more difficult for the government to spend money on all of its priorities, and more often than not, makes for some tough decisions.

Recessions are defined slightly differently in the US, with some wider factors considered. But in line with the above, the US has already entered a technical recession following two quarters of negative growth over the first half of the year. The FED had hoped they could cool inflation without causing a recession, however historically this is proven to be a near impossible task.

In the UK, the Bank of England’s most recent comments suggested the UK will not only go into recession towards the end of 2022, but it could last until the end of 2023 or start of 2024.

This can have different effects on different types of bonds. Some government bonds, like those issued by countries including the UK and the US, often have a better chance of holding or increasing their value as they’re deemed to be ‘safer’ investments. However more risky corporate bonds could suffer, with the chances of companies not being able to pay their debts being higher during a recession.

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.

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.

Past performance is not a guide to the future.

The best performing Wealth Shortlist fixed income fund over the last year was M&G Global Macro Bond with a return of -1.81%*.

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 12 months. The managers have been defensively positioned, due to concerns around inflation and interest 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 -14.37%** 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 interest rate rises have resulted in the fund losing money over the period. As this is a passive fund, performance is not 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 is not a guide to the future. Source: *Lipper IM to 31/07/2022.

Past performance is not a guide to the future. Source: **Lipper IM to 31/07/2022.

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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.