Interactive Investor

The Briefing: Strategic bonds

25th November 2014 09:44

Rob Griffin from interactive investor

There are a number of reasons to love the Strategic Bond sector. As well as providing access to fixed interest, which most people should hold as part of a diversified portfolio, it gives fund managers tremendous freedom to find exciting opportunities across the marketplace.

In contrast to the Corporate Bond and High Yield sectors, this means its funds have greater scope to switch between different types of credit, depending on the economic backdrop. For example, they may opt for traditional government bonds at one stage, and riskier high-yield bonds at another.

According to Stuart Rumble, fixed income product manager at Fidelity Worldwide Investment, this benefit shouldn't be overlooked. "The great advantage of this wider remit to invest across the spectrum is that a fund can pick the best bits from the market and try to avoid the worst," he says.

A prime recent example would be high yield. Despite having gone through a period of stress over the past few months, Rumble argues that there are still some parts that can be relied upon to help deliver decent returns to investors.

To find out how to achieve a high level of return, through a combination of income and capital growth, read: Fund to watch: Invesco Perpetual Tactical Bond.

"We recognised there's some value created by this recent sell-off but don't want to become overly concentrated in this area as it is higher risk and correlated to equities," he explains. "We can pick the best bunds in this area but are mindful of the overall profile."

The Investment Management Association's (IMA) Strategic Bond sector was formed six years ago as a result of the decision to split the existing UK Corporate Bond and UK Other Bond sectors into Sterling Corporate Bond, Sterling Strategic Bond and Sterling High Yield sectors, following a review of fixed income.

The definition of the sector is being home to funds that invest at least 80% of their assets in Sterling denominated (or hedged back to Sterling) fixed-interest securities, including convertibles and preference shares.

The relatively wide scope of Strategic Bond funds means that investors in these portfolios don't have to worry about choosing between different fixed-interest investments as that will be down to the manager of the fund they have bought.

However, this has its pros and cons. While Patrick Connolly, a certified financial planner at Chase de Vere, is very positive about the IMA Strategic Bond sector and says it's the preferred way for investors to invest in fixed interest, he also stresses it comes with some caveats.

"While the sector includes some of the best fixed-interest managers and teams, it has a wide range of funds, many of which adopt different approaches," he says. "It is imperative that investors do the necessary research before deciding where to invest."

With the possibility of managers getting it wrong, he points out, this could mean investors are potentially taking on far more risk than they realise. "It would be a mistake to think that one Strategic Bond fund is necessarily like another," he adds.

Funds can vary considerably in terms of the amount of freedom given to the manager, the types of assets they invest in, the number of holdings they have and the term remaining of individual holdings.

Alongside the mainstream government bonds, investment-grade corporate bonds and the high-yield universe, there are also opportunities within various financial instruments, such as derivatives, as well as loans and residential mortgage-backed securities.

Is this the right sector for me?

Consider investing in this sector if...

  • you want a one-stop-shop approach to fixed income investing
  • you want a fund that has flexibility as to where it invests
  • you are looking to diversify your portfolio

While some Strategic Bond managers will stick quite rigidly to traditional sources of income, such as investment-grade corporate bonds and high yield, others will seek to embrace the more esoteric areas of the market. Anyone investing needs to understand the outlook of these managers.

Alister Brown, product director of fixed interest at Invesco Perpetual, says asset-allocation decisions increasingly depend on market and economic issues.

"We take risk when we think we're being rewarded for doing so, such as when there have been attractive yields or the prospect of good capital appreciation," he says. "Conversely, when yields are low and spreads over government bonds are tight we'll position the fund very defensively."

Even the funds of managers with similar remits may look and perform very differently to one another. Over the past five years, the average return for the IMA Strategic Bond sector is 39.1%, according to Morningstar figures compiled to 7 November 2014 but individual returns vary enormously.

While the best funds have delivered in the region of 66% over this time frame, the worst have only managed around 14%. This is a staggering difference between funds that some investors may see as being one and the same.

Looking ahead, Nick Gartside, manager of the JPM Strategic Bond fund, expects demand from investors for Strategic Bond funds will grow, pointing out there's a noticeable shift from traditional, benchmark-oriented, fixed-income strategies to more benchmark-agnostic, flexible approaches.

"Rising flows in recent years to this category would suggest investors believe they are likely better suited for today's uncertain bond investing landscape," he adds.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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