Investing in bonds is back on the radar, as a spate of central banks across the world have recently brought an end to the era of rising interest rates - before it even truly got started.
Having initially planned to raise interest rates incrementally in 2019, the US Federal Reserve announced in March that it does not plan to raise rates for the rest of the year, due to slower economic growth. It’s a move which has been echoed by the likes of the European Central Bank and the Bank of Japan.
Interest rate rises are usually bad news for bonds: when rates go up, bond prices generally fall. For example, new bonds being issued will pay a higher yield to reflect those higher rates and make them more competitive vs cash. This reduces the attractiveness of existing bonds with lower rates.
As rate rises now seem to have been paused for the foreseeable future, fixed income is looking more attractive to investors: according to the Investment Associations, fixed income has provided three of the top five best-selling investment sectors for net retail sales (Strategic Bonds, Global Bonds and UK gilts) in March 2019. In total there were £810m of net retail sales in fixed income in March, compared with £630m of outflows for equities.
Below we look at a number of areas of the fixed income market that investors may want to consider.
One way for investors to swerve the difficulties of choosing between a gilt, corporate or high-yield bond fund – and the individual challenges each sector of the bond market faces – is to use a strategic bond fund. These funds have grown in popularity in the past decade as they give managers the flexibility to diversify their bond holdings across a range of sectors, allowing them to shift allocations as they see fit.
Chelsea Financial Services senior analyst Ryan Lightfoot-Brown says: “The markets can move quickly on sentiment towards lowering or increasing rates – this makes flexibility the order of the day. We like experienced managers in this space such as the Baillie Gifford Strategic Bond fund, managed by Torcail Stewart and Lesley Dunn and the Invesco Monthly Income Plus fund, managed by Paul Causer, Paul Read and Ciaron Mallon. Both are run by strong stock pickers who have demonstrated outperformance in the long-term.
High yield bonds are an option for investors who are not getting the income they need from investing in investment grade bonds. Chelsea Financial Services managing director Darius McDermott says although the risks are higher in this area of the market, the amount of research is higher “to fully understand the company, its outlook and whether the risk is worth taking”, he believes this is why an active manager is essential.
Darius says: “I would highlight the Aviva High Yield Bond fund. Managers Chris Higham and Sunita Kara invest in 80 to 100 holdings and the strengths of the teams’ stock picking ability is evidenced by the low to non-existent default rate (when the company defaults on its loan).”
Despite being out of favour recently, the corporate bond sector is home to many of the biggest managers in the fixed income space. The sector is rife with strong active managers, as demonstrated by the strong performance seen by these funds in the aftermath of the global financial crisis between 2007 and 2009.
Chelsea Financial Services senior research analyst James Yardley says: “M&G Corporate bond fund is a good starting point for investing in the sector. Manager Richard Woolnough and his team undertake detailed credit analysis with an emphasis on avoiding losers, rather than picking winners, and performance has been consistent since launch. The TwentyFour Corporate bond fund is also a strong option for investors as it has a focus on minimising risk. We appreciate the fact that manager Chris Bowie likes steady bonds which will not give him sleepless nights.”
Of course, those not willing to go exclusively down the fixed income route can use a multi-asset fund which offers exposure to both equities and fixed income. Lightfoot-Brown highlights the Jupiter Distribution fund as an option for a risk averse investors. This fund, launched in 2002, has an approximate 70:30 ratio between holdings in fixed income and equities, with the allocation actively managed. The equities allocation is limited to 35%.
He says: “This fund could be a good option for cautious investors, or those at or approaching retirement. It has consistently outperformed the Investment Association Mixed Investment 0-35% shares sector in the medium to long-term, and offers investors a bit of added security. It may especially appeal to those looking to control risk and preserve capital.”
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the authors and do not constitute financial advice.