While sentiment towards the asset class has turned increasingly downbeat over recent months as yields are near all-time lows and a high proportion of developed market sovereign bonds are now in negative territory, the threat of deflation and the huge levels of debt of the system are reasons why prices may continue to rise.
Also, even though the longer term outlook for bonds looks poor given their current valuations, the fact of the matter is that most investors will want some form of protection against risk assets (which aren’t hugely cheap either) within their portfolios and therefore it is unlikely that private and professional investors will give up on the asset class altogether.
Therefore, in the next article in the series, we take a closer look at five of the FE Research team’s favourite fixed income funds for investors to consider this ISA season.
M&G Optimal Income
We start with M&G Optimal Income, which at £24.5bn, is the largest UK based open-ended fund in the IA universe.
The fund is headed up by Richard Woolnough, who recently walked away with the best FE Alpha Manager of the Year award due to his ability to consistently add value to his investors’ money over time.
Though concerns have been raised about the size of M&G Optimal Income and the FE Research team has noted that its growing AUM means Woolnough will struggle to add value on a stock-by-stock basis, they say the flexible nature of the fund’s remit and the manager’s top down-approach to the market mean it can continue to outperform.
“Woolnough is much less constrained in this portfolio than in the other ones he manages. Here he can express and implement his views more accurately and as a result M&G Optimal Income has beaten its sector,” the team said.
“Woolnough and M&G’s expertise in the fixed income area means the fund is expected to continue performing well, although the size of the fund is becoming more and more constraining.”
M&G Optimal Income was launched in December 2006 and, according to FE Analytics, it has been the second best performing portfolio in the IA Sterling Strategic Bond sector over that time with returns of 90.01 per cent and has nearly doubled the sector average in the process.
Performance of fund versus sector since Dec 2006
Source: FE Analytics
Our data shows the fund has also beaten the sector average in six out of the last eight calendar years. One of those two exceptions was 2014 when Woolnough’s decision to be negative duration in Europe hindered returns.
M&G Optimal Income has a yield of 2.19 per cent and an ongoing charges figure (OCF) of 0.91 per cent.
Fidelity MoneyBuilder Income
Sticking on the theme of experienced managers, next up we look at Fidelity Moneybuilder Income which is run by Ian Spreadbury who, along with Woolnough, is one of only two fixed income FE Alpha Manager ‘hall of famers’.
Spreadbury’s £3.4bn fund sits in the IA Sterling Corporate Bond sector and the team at FE Research rate the manager’s experience and more cautious approach to the fixed income market.
“This bond fund is set up to be a good diversifier to a portfolio of other assets such as equities. We agree with the manager that bond funds which minimise these exposures can’t offer the diversification of a traditional bond portfolio,” FE Research said.
“The manager runs the fund in a very cautious way and this should help limit losses if credit conditions worsen. This is a good core bond portfolio to hold for the long term.”
Spreadbury has managed Fidelity Moneybuilder Income since its launch in September 1995, over which time it has been the fourth best performing portfolio in the sector with returns of 233.89 per cent.
The fund is also comfortably outperforming over five and 10 years and is one of the sector’s best performing funds for its maximum drawdown, which measures the most an investor would have lost if they had bought and sold at the worst possible times, its risk-adjusted returns and annualised volatility over those time frames.
Fidelity Moneybuilder Income has a yield of 3.55 per cent and that is due to Spreadbury’s overweight position in BBB, BB and B rated credit. The OCF is low at just 0.57 per cent.
Kames High Yield Bond
Another fund on the FE Select 100 is Kames High Yield Bond which, as it names suggests, is more esoteric than the two portfolios mentioned so far as it focuses on lower-rated credit.
The £1.5bn fund is managed by Philip Milburn and Claire McGuckin and while there are concerns about high yield bonds considering the strong returns they have delivered over recent years, the team at FE Research think it is one of the best options available to investors who want specialised exposure to the asset class.
“Investors willing to take this risk can get a decent level of income from this fund and benefit from the stock-picking skills of the two managers,” they said.
According to FE Analytics, Kames High Yield Bond has been a top quartile performer in the IA Sterling High Yield Bond sector over 10 years with returns of 90.57 per cent and it is outperforming over one, three and five years.
Performance of fund versus sector over 10yrs
The fund’s largest regional exposure is the US as the managers think is better priced than euro or sterling bonds. The managers also use derivatives to lower their overall interest rate risk. Kames High Yield Bond only yields 4.2 per cent, illustrating the asset class’ strong performance over recent years.
Its OCF is 0.79 per cent.
GAM Star Credit Opportunities
One of the major concerns experts have raised about the current bond market is that, given the falling levels of liquidity in the corporate credit space and low yields on offer, larger fixed income funds could be most at risk if there were to be a dramatic sell-off.
However, at the same time, the longest-serving managers who have dealt with varying conditions tend to run the largest funds because of their experience.
One fund which has a relatively small AUM, but is headed-up by a manager who has witnessed a number of different market cycles, is FE Alpha Manager Anthony Smouha’s £167m GAM Star Credit Opportunities fund.
Smouha has managed bond funds since the early 1990s but launched this five crown-rated in July 2011.
The manager takes a relatively unique approach to the corporate bond market as he will focus on investment grade issuers, but look further down their capital structure to generate a higher portfolio yield.
This approach has worked in the past as GAM Star Credit Opportunities has been the second best performing portfolio in the IA Sterling Strategic Bond sector since its launch with returns of 53.58 per cent, beating its Barclays Sterling Aggregate benchmark by more than 20 percentage points in the process.
The fund has a yield of more than 5 per cent and an OCF of 1.18 per cent.
Natixis Loomis Sayles Multi Sector Income
The final portfolio on the list is the Natixis Loomis Sayles Multi Sector Income fund.
While it is a relatively unknown offering among the UK investor community, the Irish-domiciled fund has amassed an AUM of £1.4bn and is headed up by three FE Alpha Managers; namely Dan Fuss, Elaine M. Stokes and Matthew J. Eagan.
At FE’s inaugural Alpha Manager of the Year awards, Eagan was named the best newcomer as he only received the coveted rating at the latest rebalancing.
It isn’t too difficult to see why he, and his two co-managers, are so highly rated by the FE Research team, though. Our data shows the fund has been a top quartile performer in the IA Global Bond sector and has comfortably beaten its Barclays US Government/Credit benchmark since its launch in September 2007.
Performance of fund versus sector and index since Sep 2007
Source: FE Analytics
Natixis Loomis Sayles Multi Sector Income has beaten the sector average in every calendar year since 2009 and is outperforming once again in 2015.
The managers’ investment approach combines bottom-up security selection with top-down strategic macroeconomic views and they are currently overweight higher yielding bonds relative to their benchmark. The fund also has 5.4 per cent in equities.
Its yield is 4.2 per cent and total expense ratio is 1.5 per cent.