Due to the concern that bond-holders are likely to be hit with capital losses, industry experts told FE Trustnet this morning that investors should be focusing on fixed income funds with a high degree of flexibility and an experienced management team if they want to successfully navigate the uncertain market.
Two high-profile portfolios that immediately spring to mind are FE Alpha Manager Richard Woolnough’s M&G Optimal Income fund and FE Alpha Manager Ariel Bezalel’s Jupiter Strategic Bond fund, both of which sit in the IMA Sterling Strategic Bond sector and have the coveted five crown-rating.
Both managers are highly rated and respected by fund researchers and analysts due to their strong track records in terms of their capital growth and protection and because of their knowledge of the fixed income market.
Woolnough launched his now £21.3bn fund in December 2006, over which time it has topped the sector with returns of 86.99 per cent.
Bezalel has the shorter track record, launching his £2.1bn Jupiter Strategic Bond fund in June 2008. Our data shows that it too has been the sector’s best performing portfolio since its inception, delivering a return of 85.17 per cent.
M&G Optimal Income has also considerably outperformed the sector over that time, but has fallen short of Bezalel’s fund by 5 percentage points. Although neither fund tries to beat equities, both have also considerably outperformed the FTSE All Share over that time, but with significantly less volatility.
Performance of funds vs sector and index since June 2008
Source: FE Analytics
Both funds clearly have a good long-term track record, but which one is best suited to which type of investor?
Looking at the discrete performance, there are no real signs to suggest that either fund takes advantage of certain market conditions more than the other. The Jupiter fund has outperformed the sector in each calendar year since its launch, while the M&G fund only underperformed in 2012.
In that year, however, Woolnough only underperformed against Bezalel by a couple of percentage points.
Most of that period was particularly good for bond-holders, as yields fell across the fixed income market between 2009 and early 2013.
The real challenge was last year’s “taper tantrum”, when the Fed’s comments over the future of QE caused the prices of bonds to fall. This hurt the large majority of managers in the various IMA fixed income sectors, and Woolnough and Bezalel were no different.
However, as the graph below shows, while M&G Optimal Income did outperform Jupiter Strategic Bond in 2013, it fell further during the May/June sell-off.
Performance of funds vs sector in 2013
Source: FE Analytics
If you were to look at the two funds' capital preservation characteristics since Bezalel launched his portfolio, however, it is a different story.
According to FE Analytics, M&G Optimal Income has been a top-quartile performer in terms of its maximum drawdown, downside risk, annualised volatility and sharpe ratio over that time and has beaten the Jupiter fund over all four of those measures.
That is probably a reflection of the fact that the Jupiter fund fell twice as far as Woolnough’s portfolio during the Lehman Brothers crisis in the final months of 2008.
M&G Optimal Income has defended capital more effectively, which is one of the main characteristics investors want in their bond funds. The other major reason investors want bonds in their portfolio is because they offer a reliable source of income and our data shows that Bezalel has distributed more to unit holders over the long-term.
Our data shows that if an investor had bought £1,000 worth of units in Jupiter Strategic Bond the day it was launched, they would have earned £387.89 in income. M&G Optimal Income has paid out £267.69 on a £1,000 investment over that time.
Bezalel has also distributed considerably more over one, three and five years.
Source: FE Analytics
Jupiter Strategic Bond currently yields 5.2 per cent while M&G Optimal Income has a yield of below 3 per cent.
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, says that Bezalel has been able to pay out more income because he has had a higher weighting to lower-rated credit. He says this shows one of the major differences between the two managers' styles.
“Ariel has historically been very successful in the more esoteric areas of the market, for instance I remember him doing very well from buying oil rig finance bonds a few years ago,” Morgan (pictured) said. “He hasn’t been afraid to take on risk over the last few years by going longer duration and buying high-yielding debt. He really does like to explore some of the more esoteric areas and because it is a smaller fund, he has been able to take meaningful positions in some of those niche areas.”
“To be fair, I don’t think Richard Woolnough can do that with the size of his fund. However, he has normally added value by getting his duration right and picking the right areas of the global bond spectrum.”
The two portfolios do look quite different at the moment.
While Bezalel holds certain safe-haven securities such as Australian government bonds to hedge risk, he still has the majority of his portfolio in higher yielding, and theoretically more risky, bonds. Forty-eight per cent of the portfolio is invested in credit rated BB and below.
Woolnough, on the other hand, has two thirds of his fund in government bonds and investment grade credit. He has also taken advantage of his 20 per cent equity allowance in the past, with shares currently making up 5 per cent of the portfolio.
Bezalel has stated in the past that it is very unlikely that he would use equities within his fund.
The expert’s view
Morgan rates both funds and says in this instance, there is little to choose between the two in terms of their risk profile.
Also, as both managers are not afraid to change their portfolios quite aggressively to suit differing market conditions, he says that looking at how they have performed in the past – in terms of their capital growth and income distribution – can’t be used to judge future returns.
“It’s very difficult to say which one is more risky, as one has a lot of high yield and the other will hold equities,” Morgan said.
“However, some of Bezalel’s lowest-rated bonds will behave like equities. On top of that, both will change their portfolios quite aggressively. It’s a difficult question to answer; I would say that both are more risky than the average, but in different ways.”
It is important to note that both managers use derivatives and forward transactions to mitigate risk and to try to add alpha, again potentially adding to their risk profiles.
The one major difference between the two portfolios is their size.
Jupiter Strategic Bond is by no means small at £2.1bn, but Woolnough’s fund at £21.3bn is the largest UK-based fund in the IMA fixed income sectors. When you combine his M&G Corporate Bond, M&G Strategic Corporate Bond and M&G European Corporate Bond, Woolnough currently runs more than £30bn.
Woolnough’s backers say that he has the best bond team in the UK behind him and has broadened its expertise to counter the sizeable AUM. They also rightfully point out that its size hasn’t affected performance so far.
The manager has said in the past that there are no immediate plans to soft-close, but has admitted that every day the fund grows, it becomes harder for him to manage.
Morgan thinks that must be the case and says the fund’s future performance will depend on Woolnough’s ability to get his macro calls right, while Bezalel has an extra string to his bow as he can still add value on a stock-by-stock basis because he runs a smaller fund.
M&G Optimal Income has an ongoing charges figure (OCF) of 0.91 per cent, while the Jupiter fund is slightly cheaper at 0.74 per cent.
