I say most, as certain funds within the IMA Sterling Strategic Bond sector are still throwing off a yield of 6 per cent or above, which looks very attractive given that interest rates are still at 0.5 per cent and gilts yield 2.2 per cent.
However, in an article last week Baillie Gifford’s Torcail Stewart warned that some of his peers had been taking the sector’s flexible restrictions to the extreme in order to generate those sorts of yields, putting their investors’ hard earned savings at risk as a result.
Though he mentioned the sporadic use of more esoteric securities such as catastrophe bonds and convertible debt, he warned that some of his competitors were relying too much on junk bonds.
While he admitted the chance of a spike in defaults is low for the time being – given that interest rates are expected to stay lower for longer – he said certain managers were becoming overly complacent with the risks involved with high yield bonds. FE Alpha Manager Ian Spreadbury, who runs the £1.5bn Fidelity Strategic Bond fund, agrees that investors need to be very aware of the risks surrounding the high yield market.
“As you move into the B and CCC rated credit categories, you are not really getting paid [for the of default risk]. If you are moving into those categories, you’ve got to be sure that it is an improving credit,” Spreadbury (pictured) said.
Given those concerns, FE Trustnet looks at the funds within the IMA Sterling Strategic Bond sector which have yields of 6 per cent or above and analyse how they generating such an attractive level of income.
Source: FE Analytics
Top of the list is the Eric Holt’s five crown-rated Royal London Sterling Extra Yield Bond fund with its yield of 6.82 per cent.
The £972m fund’s focus on high yielding assets has translated into strong returns for investors over recent years as, according to FE Analytics, it has topped the sector over five years with returns of 86.52 per cent.
Performance of fund versus sector over 5yrs
Source: FE Analytics
It has also paid out a huge amount to its investors over that time, as investors who bought £1,000 worth of units would have since earned £400 in income.
However, when you look at what the fund holds to generate that yield, you can see it has 40.4 per cent in BB or below rated bonds and a chunky 39.8 per cent in unrated bonds.
Nevertheless, Holt says though the search for yield can mean investors take undue amounts of risk, he disputes the claim that he is in that category even though he holds perceivably higher risk bonds.
“A lack of rating in itself does not imply any specific level of risk, but typically such bonds offer investors a claim on assets or cash flows,” Holt said.
“There are three unrated bonds in the fund’s ten largest holdings – two are mortgage debentures with first and over-collateralised claims on commercial property – while the third is regulated operating company debt within the £1.7bn market capitalisation Phoenix Group.”
“We also agree that in the present market environment there is a risk that funds ‘reach for yield’ – seeking increasingly risky assets in order to sustain the yield they offer. Within this context it is perhaps worth noting that there are seven common holdings between the fund’s current ten largest holdings and those as at end 2012.”
Despite that, Holt fully agrees investors need to understand the risk profile of a fund in order to assess its suitability, especially when it comes to fixed income.
Next on the list is the JPM Income fund, which is one of the newest entrants to the sector as it was launched in June this year.
Given that it only launched a few months ago, data on its holdings isn’t freely available at the moment but a spokesperson from JP Morgan says the fund’s current yield of 6.76 per cent shouldn’t be taken at face value.
The spokesperson says yield is more the “function of accounting”, as the group say the fund’s yield is approximately 5.75 per cent before fees and taxes.
“The yield of close to 7 per cent currently shown on the factsheet is higher than the actual economic yield of the portfolio,” they said.
“This statistic is provided by a third party and reflects certain accounting conventions that can lead to differences between the economic return and income accrued in certain periods. We have made adjustments to more properly reflect the yield of certain mortgage-backed securities that along with other fixed income sectors add to the fund’s diversification.”
Though the fund does have exposure to higher yielding assets such as US mortgage backed securities (MBS), the spokesperson also says it is a very diversified portfolio which isn’t overly reliant on one area of the market.
The £704m Henderson Fixed Interest Monthly Income fund, which is headed up by the FE Alpha Manager duo of Jenna Barnard and John Pattullo, has a yield of 6 per cent, according to FE Analytics.
Nevertheless, Pattullo says he isn’t putting his investors’ income at risk.
He says the fund is aimed at those investors who want income, rather than huge capital appreciation, noting that it has more than 200 centurions invested in the portfolio. The fund therefore takes charges from the capital, rather than the income.
Pattullo says his investors are fully aware that the fund can be volatile from a total return perspective, as shown over recent months, but the income they receive isn’t in danger.
Performance of fund versus sector in 2014
Source: FE Analytics
Henderson Fixed Interest Monthly Income currently holds 8 per cent in CCC and below rated bonds, 3.2 per cent in unrated bonds and 7.1 per cent in secured loans.
The manager says that though they can be quite volatile from a price point of view, the lower-rated bonds he holds are safe as they are issued by non-cyclical companies.
“I have sympathy with the view that you don’t want too much in CCC or below rated credits,” Pattullo (pictured) said.
“However, we don’t mind lending to a CCC-rated non-cyclical company. The AA is a good example of that, as though it generates £430m in earnings, it is more than six times leveraged. However, those earnings are stable as it is a classically non-cyclical business as people, like me, will always fork out for membership.” Pattullo is concerned, however, that some of the funds in the sector are taking too much risk. Though he didn’t name any names, he says investors do need to be wary.
“Certain members of the peer group are taking some quite punchy calls. They are trying to generate an unsustainable yield by chasing some fairly hairy credits,” he said.
The final fund on the list is L&G Dynamic Bond, which also has a yield of 6 per cent.
While Martin Reeves, manager of the fund, has been upping his exposure to high yield bonds since he took over from Dickie Hodges, a spokesperson from L&G says that like JPM Income, the yield figure isn’t fully representative of the current portfolio.
“Often the yields on bond funds are expressed on a trailing basis. Considering a forward looking yield to maturity measure instead, the yield on the Dynamic Bond Trust is approximately 4 per cent,” the spokesperson said.
