Managers within the IMA Sterling Strategic Bond sector are permitted to hold up to 20 per cent of their fund in equities. While the large majority of strategic bond managers only invest in fixed interest assets, our data shows that 14 of the 76 funds within the sector have exposure to the equity market. According to FE Analytics, the strategic bond funds with the highest weightings to shares are Invesco Perpetual Monthly Income Plus, Artemis High Income, AXA Framlington Managed Income, M&G Optimal Income and Royal London Sterling Extra High Yield.
Source: FE Analytics
Our data shows that those funds’ weighting to equities have been consistent over the last 12 months.
Prices of traditional fixed income assets have trended lower recently and therefore the fact that those funds have had a decent degree of their portfolio invested in equities will have helped them to outperform recently on a relative basis.
While the purpose of the sector is to allow managers a greater degree of flexibility for their investors, a high proportion of investors will want to use bond funds to balance out their equity exposure within their portfolios, and a weighting to equities in their bond funds will reduce their diversification.
Morgan, pensions and investment analyst at Charles Stanley Direct, says investors need to check strategic bond funds carefully before they buy in order to make sure that the fund is in line with their appetite for risk.
“It’s definitely something investors should be aware of,” Morgan said.
“These are the types of funds that are going to be at the top of the sector because of that weighting but when things go into reverse, they won’t be. They are very much top or bottom quartile funds.”
“For investors, it’s all about looking under the bonnet instead of just looking at headline returns. Even if a fund has performed well, you want to find out how those returns have been driven and how much risk the manager has been taking.”
His thoughts are very similar to those of Whitechurch’s Ben Willis, who told FE Trustnet last year that there is little point choosing strategic bond funds on recent performance as the outlook for fixed income, especially high yield, now looks very different.
According to FE Analytics, Invesco Perpetual Monthly Income Plus, Artemis High Income, AXA Framlington Managed Income, M&G Optimal Income and Royal London Sterling Extra High Yield all delivered top decile returns in 2013; which was a year when most bonds fell and equities – as well as high yield credit – rallied.
Performance of funds vs sector in 2013
Source: FE Analytics
Apart from M&G Optimal Income, those funds also sit in the top quartile over a cumulative one year period.
Neil Shillito (pictured), director at SG Wealth Management, says there is a real risk that investors are buying into these funds for their bond allocation due to strong past performance, but without realising that the managers have a high weighting to equities.
“It’s very true,” Shillito said. “The name strategic bond is very misleading. For instance, we have used Invesco Perpetual Monthly Income Plus in the past and it has been very successful, but investors clearly need to understand that it isn’t an out-and-out bond fund.” Shillito also points out that it causes a headache for investors who are trying to build a portfolio, because while strategic bonds with a high weighting to equities will undoubtedly outperform when bonds struggle, they are also likely to fall just like equity funds when appetite for risk subsides.
While he agrees that it can put fund selectors in a difficult position, Morgan says that strategic bond managers are fully within their rights to hold equities.
“They can only hold 20 per cent in equities, though it is quite unusual for them to have more than 10 per cent. However, strategic bond managers across the fixed income asset class from gilts to investment grade credit to high yield.”
“Once you go below high yield, you are in equities which means you’re investing in the lowest part of the corporate structure.”
“However, if the manager knows the business inside out and knows its credit-worthiness, it’s a legitimate decision to invest in its equity.”
Morgan also points out that certain funds in the sector, such as five crown rated Invesco Perpetual Monthly Income Plus fund, clearly state that their equity allocation is a structural part of the portfolio that will always be there.
For instance, the fixed income mandate of the fund is headed up by the highly experienced duo of Paul Causer and Paul Read while the equity mandate, which will normally be roughly 20 per cent of the portfolio, is managed by Ciaran Mallon.
Mallon took over the mandate from star manager Neil Woodford, who is soon to launch his own fund management group.
The £3.9bn Invesco Perpetual has performed well, having been the best performing fund in the sector over 10 years with returns of 117 per cent.
Performance of fund versus sector over 10yrs
Source: FE Analytics
However, it has fallen a long way in the past when sentiment towards equities has turned negative. For instance, in 2008 it lost 23.21 per cent and in 2011 it lost 3.55 per cent, meaning it was one of the sectors worst performers during those years.
While Morgan does rate the fund, due to the way it and others fund invest, comparing its performance to the sector average – which is predominantly made up of pure bond funds – is like comparing “apples with pears”, he says.
