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What to do if you’re already invested in bonds

24 June 2013

Hargreaves Lansdown’s Richard Troue says investors should reconsider what exposure they have to fixed income rather than giving up on the asset class altogether.

By Jenna Voigt,

Features Editor, FE Trustnet

When Ben Bernanke announced the Federal Reserve would start tapering quantitative easing later this year, his words triggered the long-awaited, and some say inevitable, rise in bond yields from the world’s "safe haven" markets.

UK gilts are now at a two-year high, rising above 2.5 per cent on 10-year paper, on the back of the news. Their US counterparts, Treasuries, are now at 2.6 per cent – a full percentage point higher than the start of last month.

The rise in yields has seen both government bond markets lose money in recent months, as the graph below shows.

Performance of indices over 3months

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Source: FE Analytics

With such marked volatility in this market, and many experts predicting yields will rise further still, investors have become uncertain of what to do with their existing bond investments.

Low yields have already driven investors into risky areas of fixed income – emerging market debt and high yield bonds, for example – which are particularly susceptible to an all-out sell-off that the abatement of QE could spark.

So where is there to turn when bonds are starting to look too risky?

Hargreaves Lansdown’s Richard Troue (pictured) says it would be next to impossible to call the bottom of the market, and warns investors not to react too quickly even with bond yields slipping higher.

ALT_TAG Although equity valuations are regarded as more attractive than those of bonds, Troue says they cannot possibly be used as an alternative because they are far more susceptible to severe and sudden losses.

"While interest rates are still so low and there are plenty of risks out there to the global economy, there’s still a chance we’ll get risk-on/risk-off periods where bonds do well and investors see them again as a safe haven," he said.

"It’s difficult to see whether investors should move out of government and investment grade bonds because they could still do well and investors would also be missing out on some yield."

"If you get that call wrong, you’re hitting [investors] with a double whammy."

Troue adds that the rising yields on US Treasuries and gilts may make them more attractive to risk-averse investors before long, as they will once again deliver a yield in excess of inflation.


Instead of fleeing from bonds entirely, Troue says investors should consider switching out of specific government bond, corporate bond or emerging market debt funds, and into a globally focused strategic bond fund that has the flexibility to invest across the entire fixed income market.

Troue likes the $215.2m Old Mutual Global Strategic Bond fund, managed by FE Alpha Manager Stewart Cowley, and the five crown-rated Jupiter Strategic Bond fund, headed up by FE Alpha Manager Ariel Bezalel.

"We like a broad range of flexible fund managers that have the capacity to vary their exposure across the fixed interest market," he said.

Cowley’s Old Mutual Global Strategic Bond fund was only launched in to the UK market in February last year. It has underperformed other global bond funds over the past 12 months, losing 1.19 per cent.

The Jupiter fund has fared well over its five-year history, returning 70.54 per cent – well ahead of both the IMA Sterling Strategic Bond sector and the iBoxx Sterling Non Gilts All Maturities index, which is its benchmark.

Performance of fund vs sector and index over 5 yrs

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Source: FE Analytics

The Jupiter fund is yielding 5.2 per cent compared with 2.1 per cent from Cowley’s Old Mutual fund.

Troue says Bezalel’s outperformance comes from his global focus and high yield exposure, but adds that he has holdings in less correlated debt, such as pubs and oil rig financials.

The Jupiter portfolio requires a minimum investment of £500 and has ongoing charges of 1.5 per cent. Old Mutual Global Strategic Bond requires a minimum investment of £1,000 and has ongoing charges of 1.32 per cent.

Jason Hollands, managing director of business and communications at Bestinvest, agrees that investors who want to retain exposure to the bond markets should make sure they only buy funds with the maximum amount of flexibility.

"Yields have gone out quite a bit already, but a lot of the longer-duration bonds still have negative yields and so the correction could go further," he said. "For this reason, we would go for bond funds that are very flexible and that have a focus on short-duration bonds."

Hollands sees cash as a viable short-term bet, but thinks forecasting an all-out crash in bond markets at this point is premature.

"Cash is a possibility – if you want to get out full-stop, then obviously cash is the choice because it’s the lowest-risk area of the market," he said. "However, you’re not going to get much in the way of returns so it doesn’t make sense beyond the short-term."

Troue says that rather than staying well away from bonds at times like this, investors should instead ensure they have well-diversified portfolios, blending different areas of the fixed income market, and should also consider adding UK Equity Income exposure if they have not already done so.


The analyst says it is often best to blend different types of UK Equity Income funds, such as large cap focused portfolios Invesco Perpetual Income and Liontrust Macro Equity Income, with those that invest further down the market cap spectrum, such as Marlborough Multi-Cap Income or JOHCM UK Equity Income.

"You need a good spread of investments across defensives and cyclicals there," he said.

The five crown-rated Invesco Perpetual Income fund is managed by Neil Woodford, and is the staple choice for investors who want core equity income exposure.

The £10.6bn fund has consistently outperformed the IMA UK Equity Income sector over one, three, five and 10 years. It tends to invest in more defensive, large cap names – partially owing to its size.

Over 10 years, the fund has gained 204.61 per cent, nearly doubling the sector’s returns. The FTSE All Share has made 125.91 per cent over this period.

Blue chip focused Liontrust Macro Equity Income has also beaten the sector and index over five years, and continued to lead the FTSE over one and three; however, it has lagged the sector average in the shorter term.

Investors in multi-cap favourites JOHCM UK Equity Income and Marlborough Multi Cap Income have strongly outperformed the sector and index over the last year. The longer-running JOHCM fund has also soundly beaten the sector and index over three and five years.

The funds are yielding between 3 and 4.5 per cent.

Hollands says property funds may look an appealing alternative to bonds and cash given that many of them are yielding more than 4 per cent, but adds that they carry plenty of risk themselves.

"There’s been a renewed interest in property funds, but you’ve got a lot of refinancing risk in the market over the next year or so, which makes me nervous," he said.

"The recovery across the market has been very fragile. If you are interested in property and are willing to wear the refinancing risk, then a fund with a bias towards London and the south-east makes sense, such as the Henderson UK Property fund, which has around two-thirds of its assets in the area," he added.

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