Willis, who is head of research at Whitechurch, says that the current backdrop of rising bond yields and gradually rising interest rates will be extremely difficult for fixed income managers, whereas over the past few years returns from the asset class haven’t been too difficult to come by. "I wouldn’t say that bond managers have had it easy, so to speak, but even if you look at index-linked to high yield you have seen a 30 per cent plus return over the past few years," Willis said.
Willis and many experts say that a multi-decade bull run in fixed income is coming to an end, which will make investing in the asset class considerably more difficult.
Investors have to be very careful of which strategic managers they now choose, he says, as the next five years is likely to be very different to the last five and the majority of their abilities have remained untested.
"Basically we are going to be relying on the expertise of the managers but there are going to be so many short-term decisions to make and no-one really has an idea what is going to happen," Willis said.
"A lot of these managers have proved they can do it in the past, but it is going to be a very different environment and they are going to have to earn their corn."
"Investors will be buying their expertise but it could be make or break, as if a manager makes one wrong call then it could very damaging and could hurt the fund for a long time to come," he added.
Yields on the majority of bond sectors have been gradually rising so far this year, which has meant many risk-averse investors who hold fixed income for safety have been hit by capital losses.
According to FE Analytics, the average fund in the IMA Sterling Corporate Bond sector has made just 1.99 per cent so far this year while the average IMA UK Gilt fund has actually lost money.
Performance of sectors year to date
Source: FE Analytics
However, a large number of investors need the relative security of fixed income.
This helps to explain why Strategic Bond funds have become more popular – the managers in the sector can look across the global bond market for opportunities and protection.
Willis says his favoured strategic bond manager is FE Alpha Manager Ariel Bezalel, who runs the five crown-rated Jupiter Strategic Bond fund.
Jupiter launched the £1.5bn fund in June 2008 and our data shows it is the best-performing portfolio in the IMA Sterling Strategic Bond sector over five years, with returns of 100.98 per cent. This is nearly double the returns of its Iboxx Sterling Non-Gilt All Maturities benchmark.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
It has also been a top-quartile performer over three years. The fund offers an above average yield of 5.4 per cent, has an ongoing charges figure (OCF) of 1.5 per cent and requires a minimum investment of £500.
Willis says that Bezalel is the pick of the bunch and someone he trusts to look after his bond allocation. However, he points out that even Bezalel has benefited from a friendly fixed income backdrop.
Bestinvest’s Jason Hollands agrees that the next few years are going to be a lot more difficult and because of that investors can’t simply look back at past performance to see which managers they should invest in.
He adds that the rising yield and interest rate environment will sort the wheat from the chaff.
"Arguably since the credit crisis, there has been a slight de-emphasis of the need for bond selection," Hollands said.
"Stimulus and policy has driven the markets. QE and other asset purchases have meant that central banks have just been buying up large chunks of the market which has propped it up."
"As markets eventually normalise, you would expect there to be a much bigger differentiation between the winners and the losers when it comes to stock calls. Individual credit selection will become more important as the macro won’t be driving the bond market," he added.
Like Willis, Hollands says an investor’s best bet will be Strategic Bond funds.
"You are actually spoilt for choice in the strategic bond space as there are some very good managers in the sector," Hollands said.
"If you are looking for something low risk, we like the Kames Strategic Bond fund. Or there is Richard Woolnough’s M&G Optimal Income fund, which we like. We also use the L&G Dynamic Bond fund, which performed well during the credit crisis," he added.
L&G Dynamic Bond, M&G Optimal Income and Kames Strategic Bond are all run by highly experienced managers.
Although Hollands admits that the next half-decade is going to be more difficult, all three of the funds have considerably outperformed the sector over the past five years.
Performance of funds vs sector over 5yrs
Source: FE Analytics
Hollands added: "We like those funds as all of the managers have a fairly wide tool kit, so they can effectively manage their interest rate risk."
