Outflows of $9.6bn from Bill Gross’s mammoth Pimco Total Return Bond fund in June alone encapsulate the change in sentiment of late.
However FE Alpha Manager David Coombs, head of multi-asset investments at Rathbone Unit Trust Management, says ignoring bond funds is a big mistake and will leave investors exposed to huge risks.
"In an environment in which investors can lose money in bond markets, should we be abandoning bonds and switching everything into equities? Absolutely not," Coombs said.
"There are still opportunities in a rising-yield environment. It’s more about how investors use bonds in their portfolios. You might still achieve a positive return, but importantly, bonds remain a crucial tool in managing risk. And amid the recent furore surrounding outflows, it is important not to forget this."
Coombs (pictured) says there are three major risks when investing in bonds: liquidity risk, credit risk and interest rate risk.
In order to mitigate these factors, the manager prefers bond funds with wider, more flexible mandates that can react to moves in the macro economy.
"The funds we favour are macro bond funds. They have flexible mandates that can switch between these risks, using quite complex tools," he said.
"This means they are less directional and have the potential to make money in down markets."
Coombs recommends three bond funds – F&C Macro Global Bond, Ignis Absolute Return Government Bond and JP Morgan Income Opportunity – which all have a place in his Rathbone portfolios.
"All of these funds can short or zero-weight these risks in a more efficient manner than a plain vanilla, long-only bond fund," he explained.
However, he points out that investors need to be aware of the underlying strategies employed by these and other macro funds before buying them.
"The tools they use are complex, so it’s important that thorough due diligence is conducted, and investors are clear about the role of the funds in the overall objective of their portfolio," he explained.
F&C Macro Global Bond
The £408.4m F&C Macro Global Bond fund has been out of favour for several years, because it has been aggressively shorting safe-haven government bonds in anticipation of a sell-off.
However, in recent months, as volatility has ramped up in the government bond sphere, the fund has begun to outperform.
Over the last year, it has beaten its composite benchmark – split 50/50 between the Citi World Government Bond index and FTSE All Stocks index – with returns of 0.51 per cent. This compares against losses of 2.08 per cent from its benchmark.
Performance of fund vs index over 1yr
Source: FE Analytics
As the chart shows, the fund has a near negative correlation to the bond markets, meaning it would be a good defensive holding if bond prices fall further.
The highest weighting of managers Paul Thursby and Peter Geikie-Cobb is to North America, at 29.3 per cent. It has 11 per cent in cash.
The fund requires a minimum investment of £5,000 and has ongoing charges of 1.19 per cent.
Ignis Absolute Return Government Bond
Another fund that is betting against core government paper is Ignis Absolute Return Government Bond.
The portfolio was only launched in March 2011 but has already eclipsed £1bn in assets under management.
The team, led by Russ Oxley, thinks the US will start tapering QE in the third quarter, earlier than expectations, and is wary of slow growth in China.
The fund has lagged the IMA Targeted Absolute Return sector and EONIA benchmark over one year and over the last six months, but as yields have risen, the fund has strongly outperformed both measures.
Over the last three months, the fund has picked up 3.48 per cent while the sector and index gained roughly 1 per cent.
The fund requires a minimum investment of £1,000 and has ongoing charges of 1.34 per cent.
JPM Income Opportunity Plus
Coombs also likes the JP Morgan Income Opportunity fund, run by William Eigen.
The $79.8m Luxembourg-domiciled fund also launched in 2011. Since then, it has gained 14.66 per cent. The sector and Libor USD Overnight index have made 11.98 per cent and 3.92 per cent respectively over this time.
Performance of fund vs sector and index since launch
Source: FE Analytics
It has been a top-quartile performer in its Offshore Fixed Interest USD sector over the last one, three, six and 12 months.
While it does not sit in an absolute return sector, the fund aims to beat cash in both rising and falling markets. Like the other two funds mentioned earlier, it uses both long and short positions in the bond market.
Almost 50 per cent of the portfolio is in cash and cash equivalents. It is a highly diversified fund, with no more than 1.3 per cent invested in any one holding.
JPM Income Opportunity requires a minimum investment of $35,000 and has ongoing charges of 1.2 per cent. It also charges a performance fee of 20 per cent.
