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Is it still worth buying bond funds?

21 April 2014

Alliance Trust’s Rod Davidson explains why traditional bond funds won’t hold up in a rising interest rate scenario.

By Jenna Voigt,

Features Editor, FE Trustnet



Question: Can bonds still lower risk in a portfolio?

“We need to look at it in two different forms. Bonds will always form part of a balanced portfolio for investors, whether that’s individuals or institutions. We do have to recognise that given we’re at the end of a 30 year rally in government bonds then investors maybe have to think about how they invest in a slightly different way.”

“I think what we’ve really been out saying to investors is some of the funds and strategies they’ve used for the last 10 or 15 years may not be the ones that can deliver for them in a rising rate scenario. And that’s probably the biggest issue that they face today.”


Question: What risks should investors be aware of?

“When you look at investors today, they’re using credit [corporate bond] portfolios in various forms to deliver most of their income and return. Again if income’s a requirement then bonds will always form a part of that portfolio. The problem at the moment is that credit portfolios have performed very well, alongside the government portfolios, so they need to be careful about the types of strategies that they get involved in. I suppose for us one of the things that’s really a standout at the moment is the massive demand that we’ve seen over the last three or four years for high-yield bonds. Which has been great for the investors that have been in that market.”

“The only thing is now that it’s very well priced – we would say fully priced at the moment – therefore investors are maybe not being paid for the risk that that asset class could deliver over time going forward. So investors need to be careful that they don’t over-allocate to an area that actually has more equity-like risk potential.”


Question: How can investors manage these risks?


“We’ve always been cautious of what the high-yield market can deliver. In the good periods it’s an excellent returning asset class. In the bad periods it’s very volatile and returns can be seriously negative. The Monthly Income Bond fund is our core income generating strategy and we believe that you could actually generate as good a level of income as the high-yield sector but through investment grade bonds. But by managing the strategy in a slightly different way than a conventional fund in the corporate bond sector.”


Question: What is the outlook for income in fixed interest?

“Income will remain a key desire for investors. Bond portfolios in various forms should form a key component of that income delivery. Investors can use equities for income but of course there is a greater degree of uncertainty about the capital return through time. I think that is one of the things that the bond portfolios have more certainty on their delivery.”

“Of course that said, we are at a low point in the rate cycle. So I think it’s important investors understand that they should look for portfolios that can protect capital during a rising rate scenario.

So they’re not just eating their capital component to pay out on the income. And that very much means the managers that have more flexibility around their duration or interest rate sensitivity management. It’s one thing we’ve been very clear on the Monthly Income Bond fund that we run a conservative strategy in terms of the duration side, mindful that we do expect rates to rise through time, over the next 10 or 15 years. Even though they may not rise in a straight line over the next year for example.”

This article was written in collaboration with and is sponsored by Alliance Trust.

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