Are global bond funds a good place to be?

Bonds have assumed increasing importance in investors' portfolios recently, creating a need for further diversification from sterling-denominated issues. Global bond funds provide this by investing in different types of bonds around the world.

Our winning fund, Marlborough Global Bond, is a generalist providing genuinely flexible coverage of this asset class, as it can invest in any government or corporate bond.

Geoff Hitchin has been running the fund for almost 25 years. He has seen significant developments in the market over this period. He says: "One major change has been the enormous increase in the size of the bond markets and the number of people participating in them. The other notable thing is the degree of volatility we saw in the bond markets following the Lehman Brothers collapse."

He aims for a balanced approach, holding a good spread of countries and regions. Alongside its exposure to the UK, the US and the stronger eurozone countries, the fund currently has around 15% in emerging market bonds. There are no fixed weightings in government or corporate bonds. But Hitchin says that currently, given the indebtedness of many governments and the relative strength of many companies, he favours investment-grade corporate bonds, which represent about 80% of the portfolio at present.

Some of the fund's main returns over the past three years have come from its longer-dated holdings, which have increased considerably in value as a result of the lower interest rates on newly-issued bonds. Hitchin points out: "We have a sterling-denominated Old Mutual Insurance bond that has risen from a price of just under £19 in 2009 to more than £83 now, and we have a US dollar-denominated Dresdner Bank bond that has gone up from $21 (£13) to just over $80 over a similar period."

Although most fund returns come from Hitchin's bond selections, he also uses currencies to boost returns. Over the past three years, nearly 20% of the total return has come from the fund's currency exposure, with Australian and Canadian dollars showing particular strength.

Hitchin is mindful that many bond investors are looking for income, so the fund's yield is an important consideration for him. However, when he buys or sells a bond, he looks at the total value it will generate for investors in terms of both income and prospects for capital growth.

Bond funds still deserve their place in investors' portfolios, according to Hitchin. Although there has been a bull run on certain government bonds, he says yields are still attractive on many corporate bonds.

"Those who champion equities are highlighting the yields they are paying, which on my reckoning are between 2.5 and 3.5%," he says. "But if you compare that with the yield on our fund, which is paying a distribution yield of 4.64%, and factor in risk, to me it's clear that bond funds, and particularly global bond funds, are a good place to be."

Highly commended: Diversity delivers winning returns

Standard Life Global Index-linked Bond

To reflect the diverse nature of the global bond market, two funds have been highly commended: Standard Life Global Index Linked Bond and Templeton Emerging Markets Bond.

Standard Life's fund mainly invests in government and corporate inflation-linked bonds, although it can hold conventional bonds, if Jonathan Gibbs, manager since 2004, finds them attractive opportunities.

Inflation has risen again in the last couple of years, much of it generated globally, and this fund should provide some protection.

Its benchmark is the Barclays Global Inflation Linked Bond index, hedged to sterling. Gibbs says having access to inflation-linked markets around the world gives him greater scope to position the portfolio in the best-value markets. Apart from its inflation-beating potential, the fund also offers useful diversification.

Index-linked bonds have a low correlation with other bond classes and with assets such as equities and property. A global index-linked portfolio provides an even greater diversifier. Gibbs says the value of these bonds is underpinned by solid long-term demand from pension funds.

Templeton Emerging Markets Bond

Franklin Templeton is better known in the UK for its emerging markets equity funds, but it also runs strong fixed-interest funds, including Templeton Emerging Markets Bond, domiciled in Luxembourg, which is run by three managers based in the US and Brazil.

Bonds are seen as a way for more cautious investors to gain exposure to the emerging markets, and they have produced some attractive gains in recent years.

Templeton's fund has been one of the best performers in absolute terms over the past three years - good enough to pass through our filters.

Each year the Money Observer Fund Awards go to funds that have served investors consistently well. Brush up on the other winners and highly commended funds in our dedicated special section.