2015 Fund Awards: Sterling bond

Sterling bond: Best larger fund

GAM Star Credit Opportunities

Bond funds may not be as popular as they were a few years ago following the financial crisis; in fact some commentators are predicting doom and gloom for this asset class.

However, for investors who want an income from a balanced portfolio, with an element of predictability, bond funds still have a role to play, and a good actively managed fixed income fund should be able to ride out the storms.

For our award-winning larger sterling bond fund, GAM Star Credit Opportunities, reassurance comes from its focus on high-quality bonds while aiming to provide investors with a high income.

Manager Anthony Smouha admits that these two aspects sound counter-intuitive, as funds seeking to provide a higher income normally invest in higher-risk companies and countries.

However, his approach is to lend to investment-grade companies, but through their "junior" bonds rather than their senior bonds, which give holders first place in line for repayment if the company goes bust.

"The methodology is based around the idea that if a company does well it doesn't default," Smouha explains.

"This means it doesn't default on its senior, junior or subordinated debt. So if you do your homework and invest in a company which is doing well, then you can invest in the junior debt and get a much higher yield with the same amount of risk as the senior debt, and that is how we get our high income from safe companies."

He says it is like taking an equity fund manager approach, rather than that of a typical bond fund manager.

It means he looks at how much money he can earn from lending to a company that is doing well, by buying bonds lower down the capital structure, rather than working out how much he will get if something goes wrong.

Smouha sees the fact that GAM is a smaller player in the bond market as an advantage. It means he can take advantage of smaller issues of bonds that are often overlooked by larger bond investors because they need to buy in bulk, and these smaller bond issues tend to have higher yields.

Recently he has been adding to his holdings of long-dated securities. "We believe that generic interest rates will rise during the year but not by a significant amount," he explains. "For this reason, we believe that target yields of around 6% on our long-dated securities offer a good level of protection."

The 'Acc' share class was monitored for this award, with a three-year return of 55.71%. On Interactive Investor the fund's 'Instit' share class is available, which returned 56.71%.

Higher commended larger fund

Artemis High Income

Our highly commended larger sterling bond fund, Artemis High Income, has a foot in two camps. Although it invests primarily in bonds, which must make up at least 80% of the portfolio in order to qualify for inclusion in a bond sector, it also holds shares, which comprise the remainder of the fund.

Indeed, its long-term managers, Adrian Frost and Adrian Gosden, are better known as equity income fund managers. Working alongside them is Alex Ralph, who is a bond specialist.

Frost explains that finding "undervalued yield" is the aim of the fund. "What we are trying to do is to deliver the highest possible yield to our investors without risking the capital value of the fund." When buying corporate bonds, he says their main priorities are whether a company can afford to pay the interest on the bond and the capital back at the end of the term.

When choosing where to invest, he says they look first and foremost at industries and their characteristics because they believe that is what will determine a company's ability to pay back what it has borrowed. Then they look at the company.

Frost explains: "Typically what we are looking for is high yield, but coming from areas that are fairly stable and have good growth characteristics."

The 'R' share class was monitored for this award, with a three-year return of 39.8%. On Interactive Investor the fund's 'I' share class is available, which returned 42.46%.

Sterling bond: Best smaller fund

F&C Extra Income Bond

In recent years, the range of bond funds has grown significantly. Meanwhile, funds have tended to become either more specialist, focusing on, say, investment-grade or high-yield bonds, or more strategic, giving fund managers freedom to invest wherever they feel the best opportunities lie.

In some cases, however, managers appear to have forgotten about investors' need for income. The attraction of our award-winning smaller sterling bond fund, F&C Extra Income Bond, is that it takes a strategic approach but also pays an above-average yield, typically of around 4%.

The fund can offer the best of both worlds by combining investment-grade bonds, which are lower risk, with high-yield bonds, which offer potential for strong total returns in the right market conditions. Investors also benefit from the combined talents of managers Chris Brils and Rebecca Seabrook. Brils is F&C's head of global high-yield bonds, while Seabrook is co-head of the UK corporate bond team.

They invest in a diverse spread of mainly sterling- and euro-denominated corporate bonds, with a bias towards bonds issued by European companies and institutions, although they can invest further afield. They describe their investment style as "conservative".

The managers are always on the lookout for good-quality companies, particularly when it comes to high-yield bonds. Within investment grade, they focus on BBB-rated stocks. They aim to add value through active management decisions regarding asset allocation, quality allocation, credit sector selection, security selection and duration management.

This year, flows into high-yield bonds, driven by investors' increasing appetite for income, have supported the fund's performance. Much of the demand has come through European high-yield mutual funds.

The fund's weighting to B-rated bonds has also contributed positively to its returns. CCC- and lower-rated bonds as well as hybrid financials have also outperformed the overall market.

Brils and Seabrook expect the bond market to remain sensitive to fluctuations in sentiment. However, they believe high-yield bonds remain attractive, with their appeal lying mainly in the income they generate.

The managers think austerity policies will continue to dampen economic growth and that central banks will be obliged to support markets. They also think interest rates will remain low for some time, supporting demand for high-yield bonds.

The '1' share class monitored for this award produced a three-year return of 28.83%. The fund's '2' share class, available on Interactive Investor, returned 30.89%.

Highly commended smaller fund

Morgan Stanley Sterling Corporate Bond

Morgan Stanley has a low-profile presence in the UK fund industry, despite being a global player. Morgan Stanley Sterling Corporate Bond is one of just two Morgan Stanley UK-domiciled funds, although the company does run some offshore funds. It is managed in London by Ric Ford and Leon Grenyer.

The fund invests primarily in sterling corporate and other non-government bonds, but its managers can achieve a relatively wide geographic spread. About a third of the portfolio is invested in UK bonds. Other top holdings include US, French and German bonds. Ford and Grenyer believe the strong demand for and relatively low supply of these bonds is positive for this asset class.

One way they can add value to the fund is through their sector allocations. Currently, they are overweight on bonds issued by financial institutions, notably banks and insurance companies.

For the time being, they believe bonds generally will be underpinned by the commitment of central banks to easy monetary policy, and they have been encouraged by the more active stance taken by the ECB in order to deal with various crises.

In a recent report, the fund's managers say: "All this is happening at a time when financial institutions are reducing their risk levels and undertaking other initiatives that are positive for bondholders."

The 'Instit' share class monitored for this award produced a three-year return of 31.31%.

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.