Fixed income funds with high exposure to short-dated bonds, high yield credit and equities have coped best during the recent market sell-off, according to FE Analytics, while those which focus on the long end of the curve have lost the most.
Following a stellar year in 2014 thanks to equity market volatility, geo-political tensions and falling inflation expectations, bond funds in the Investment Association’s universe have had a difficult 2015 as sovereign debt yields have risen over recent months.
The worst hit has been 10-year German bunds, as yields have moved from less than 0.1 per cent up to around 0.7 per cent since April. However, yields on UK gilts, US treasuries and Japanese government bonds have also been on a clear upward trend.
FE data shows that since yields on UK gilts started to rise in late January, every fixed income sector – except IA Sterling High Yield Bond – has lost money and it is a similar story during the period since bund yields spiked substantially in early April.
Performance of indices since April 2015
Source: FE Analytics
There has been no clear-cut reason for this pattern, especially given the ECB and Bank of Japan are pumping liquidity into the system and economic growth in the US and UK has been far from spectacular – though encouraging data out of the eurozone, crowded positions and a lack of underlying liquidity have all been given as explanations.
Nevertheless, while many expect bond volatility to persist over the short to medium term, the sell-off seems to have calmed as prices on developed market government bonds have all risen over the past week.
Of course, there is no way of telling whether the sell-off is over, but in this article we take a closer look at which funds have coped well during the recent correction in fixed income markets – as well of those which have been hit the hardest.
Given the correction was induced by rising yields on government bonds, it isn’t too surprising to see that the IA UK Gilts sector has been the hardest hit since April with losses of 3.4 per cent. Every fund in the 30-strong peer group has lost money over that time and AXA Sterling Long Bond occupies the bottom percentile with losses of more than 5 per cent.
It is a similar story in the IA Global Bond sector where 91 per cent of funds are in negative territory over the period in question (the likes of Pimco GIS Euro Ultra Long Duration is down 15 per cent in sterling terms) and in the IA Global Emerging Markets Bond sector where only 21 per cent of funds have made money. They include Aberdeen Emerging Markets Bond and First State Emerging Markets Bond.
The two most widely used fixed income sectors, however, are the IA Sterling Corporate and Strategic Bond sectors and a clear pattern has emerged within those peer groups during the recent correction.
In the corporate bond sector, which is the largest of the two with assets totalling £67.8bn, funds which sit in the top quartile are those that either have a high weighting to lower-rated credit and those which invest in short duration assets.
Source: FE Analytics
As the table above shows, the best performing portfolio over that time has been Kevin Doran’s £141m FP Brown Shipley Sterling Bond fund with a small return of 0.06 per cent.
The fund, which yields 3.7 per cent, has 63.62 per cent in BBB rated credit, 5.34 per cent in BB or lower rated bonds and 10.35 per cent in non-rated debt. In his most recent note to investors, the manager explained his positioning was due to the threat of higher inflation later in the year as a result of the rebounding oil price.
“A bond with a fixed coupon and a long maturity is less desirable when inflation rises,” Doran said.
“This is because the rate on bank deposits is likely to rise with inflation, and as such the fixed coupon looks relatively less attractive than before. We continue to prefer shorter dated bonds for this reason.”
Certainly, when you look at the list of worst-performing funds corporate bond funds during the sell-off, it is those with exposure to longer duration assets which dominate.
Source: FE Analytics
While they were all top-quartile performers in last year’s rally and all delivered double-digit returns, the likes of Henderson Long Date Credit, AXA Sterling Long Corporate Bond and Schroder Long Corporate Bond have all seen losses of more than 4 per cent over the past two months – an outcome most investors are not used to from their core fixed income portfolio.
Richard Scott, fund manager at Hawksmoor Investment Management, says there is a major reason why long-dated bonds have underperformed by such a large margin.
“The more duration you’ve had, the more painful it has been holding bonds,” Scott said.
“The funds which have outperformed have been those which have been fairly agnostic about duration or those which haven’t tried to add value by making duration calls and instead tried to add value at a credit-level have held up well.”
“I think the reason for that is the back up in yields on long-dated bonds is seen by the market as coming from excessively low levels and therefore the sell-off hasn’t derailed the whole bond market. Corporate credit has held up quite well and credit spreads still look decent. On top of that, the outlook for defaults is still positive.”
Scott’s views are borne out in the data as every fund but one in the 32-strong IA Sterling High Yield sector – as lower rated bonds are inherently short-duration – has made money since bund yields started to rise dramatically.
One of the major selling points for the IA Sterling Strategic Bond sector, particularly over recent years, is that managers have a huge degree of flexibility to protect their investors during tough periods for fixed income.
That certainly seems to have been the case during the recent correction as it has a much higher proportion of funds with positive returns than in the corporate bond sector.
Again, however, the funds which have topped the performance tables have been those with a high weighting to lower-rated credits.
Source: FE Analytics
The top-performer has been Pimco Diversified Income Duration which has returned 1.82 per cent, thanks largely to the fact it is short government bonds and long high yield, emerging market debt and “other short duration instruments”.
The likes of Hermes Multi Strategy Credit, GAM Star Credit Opportunities and Natixis Loomis Sayles Strategic Income – which are all overweight high yield – are among the top-performers while Artemis High Income, which has 15 per cent in equities, is also top-decile.
Like in the corporate bond sector, the worst performing strategic bond funds have been those with overweights in long duration assets; such as Pimco GIS UK Sterling Bond, AXA Sterling Strategic Bond and Barclays Sterling Bond.
