The one-stop shop for bonds in 2024

There is an old adage that you should hold as many bonds as your age to ensure you strike the right balance between generating returns and lowering your risk profile as you get older.

For example, a 55-year-old with one eye on retirement should have 55% of their portfolio in bond funds as they prepare to move from earning money to conserving it.

While this adage is arguably flawed these days as people live longer, the fact remains that bonds are an indispensable tool in meeting the challenges of retirement. Bonds, or fixed interest investments, are basically IOUs from governments and companies in return for them paying a fixed rate of interest over a pre-determined period.

Choosing the right bond fund is no simple task, particularly in this uncertain economic environment. In addition to geopolitical concerns, bonds have – until recently – had to meet the challenge of central banks rapidly raising rates to cool inflationary concerns. Rates and bonds are inversely related, so when rates go up, the value of an existing bond goes down.

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 15 years since its launch 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. They can be flexible on duration, on currency, on credit risk or on inflation protection.

The Investment Association Strategic Bond sector currently has some £36bn of assets under management*. There is an argument that now is the ideal time for this asset class, as numerous opportunities exist within fixed income for agile investors.

Strategic bonds often thrive on the active decision-making of their managers, however, selecting the right fund can be a challenge. There are now 88 funds to choose from in the Investment Association Sterling Strategic bond sector** but investors must be aware that the additional flexibility means these funds are anything but homogenous. With the additional flexibility offered by strategic bonds comes additional risks and funds can vary widely on their outlook on the quality of bonds to hold, the geographies they are held in, as well as the duration of their bonds.

To put this into context the manager of a plain vanilla UK equities fund typically focuses on the UK market and stock selection within it. For fixed interest managers, and particularly strategic bond fund managers, they have a myriad of issues to tackle including the global macro landscape, global interest rates, regional interest rates, central bank policy and the outlook for credit. Investors must look carefully at the remits of these funds before making a selection so they understand the risks attached. This is supported by the fact that over the past five years the best performer in the sector has returned 31%, compared with a 9% loss for the poorest in the sector***.

The kicker is the income, where we’d expect something in the region of 6% in the current environment.

What did 2023 look like and the outlook for 2024?

The highly active nature of strategic bond fund managers is once again highlighted by their results in 2023. While the average fund in the sector delivered a return of 7.8%**, there were very different outcomes depending on the investment positioning of the fund. At the top, Man GLG Dynamic Income stood out with a 24.9% return, more than 11% ahead of its nearest rival, the M&G Optimal Income fund, managed by Richard Woolnough, which returned 13.5%**.

In hindsight, the opportunity was to take greater risk within the asset class – with managers spotting value within the corporate bond and high yield segments.

The Investment Association Sterling High Yield, Corporate Bonds, Strategic Bonds and Global Emerging Market Bonds were the top four performing sectors in 2023****.

The environment facing investors at the start of 2024 appears very different. Inflation has more than halved, yet growth has remained resilient. This is particularly true in the US, where the jobs market and consumer confidence has continued to power the economy forward. The long-awaited recession has yet to materialise, but the Federal Reserve is forecasting rate cuts in the year ahead. Inflation continues to drop, although this is unlikely to continue to go in a straight line from here.

This should be a benign environment for government bonds, particularly at the longer-duration end where there is more sensitivity to rate cuts. There are caveats, however: a revival in inflation is still plausible, and the level of debt held by developed market governments is still a risk if buyers start to question their credit-worthiness.

However, it is difficult to see corporate bonds repeating their 2023 success. Spreads over government bonds are low, and leave little margin for error should the economic outcome be worse than is currently expected. Managers are treading carefully, and are generally avoiding the higher-risk end of the corporate credit spectrum, where distress is likely to be felt more acutely. But the ability to switch direction quickly will be essential - giving strategic bond fund managers the ability to tap into their greater investment powers.

Funds worth considering include the likes of the Invesco Tactical Bond, which leverages off the whole fixed income team at Invesco, and the Aegon Strategic Bond fund, a global fund that can change its positioning very quickly when necessary. The managers combine longer-term strategic positions with short-term ideas. 

An alternate option might be the Premier Miton Strategic Monthly Income Bond, which, as the name suggests, aims to provide investors with a steady monthly income while minimising volatility and providing a better risk-adjusted income compared with both bond funds and equity income options. The fund currently has a yield of 6.07%^.

*Source: The Investment Association – November 2023
**Source: FE Analytics, as at 24 January 2024
***Source: FE Analytics, figures in pounds sterling for the Investment Association Sterling Strategic Bond sector, figures from 22 January 2019 to 22 January 2024
****Source: FE Analytics, total returns in sterling, 2 January 2023 to 29 December 2023
^Source: Provider factsheet at 30 November 2023

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 author and fund managers and do not constitute financial advice.