‘Higher risk’ areas of the mainstream market such as high yield bond and smaller companies funds have delivered the lowest maximum drawdown in this year’s volatile market, according to the latest FE Trustnet study.
It has been a very up and down year for investors so far in 2015 as macroeconomic headwinds have created volatility across all the major asset classes.
Traditional bonds have been some of the hardest hit though, as core developed sovereign debt assets have fallen a long way from their peak at the start of the year as economic improvements, concerns about rate rises and a lack of underlying liquidity have forced yields on US treasuries, UK gilts and German bunds higher.
Performance of indices in 2015
Source: FE Analytics
Most equity markets have also had a topsy-turvy time. While the first few months of the year were characterised by stellar gains thanks to easing in Europe and Japan along with huge rises in the emerging markets, headwinds such as the Greek debt negotiations and the bursting of the Chinese A-shares bubble have caused corrections across the market.
All told, it means some of the largest, most liquid and historically ‘safest’ areas of the bond and equity market have delivered the largest maximum drawdowns – which measure the most an investor would have lost if they had bought and sold at the worst possible times – so far this year.
And, according to FE Analytics, it is funds that focus on the perceived highest risk areas of the investible market which have delivered the smoothest returns in 2015.
For example, the 10 funds in the Investment Association universe (excluding the absolute return and money market sectors) with the lowest maximum drawdowns all focus on high yield bonds (which is debt issued by companies with low credit ratings) or short-duration fixed income.
We have priced the data on a weekly basis in this study, as although it isn’t industry standard, it is more appropriate than monthly pricing given the relatively short time frame.
The best performer in that respect is Azhar Hussain’s Royal London Short Duration Global High Yield Bond fund as the most investors could have possibly lost this year from it is a meagre 0.11 per cent.
The £272m fund, which sits in the IA Sterling High Yield sector and has more than 70 per cent of its assets maturing in the next six months, has also outperformed from a total return point of view this year with gains of 3.4 per cent.
The other funds to join Royal London Short Duration Global High Yield Bond with the lowest maximum drawdowns include Vanguard Global Short Term Bond Index, AXA US Shorrt Duration High Yield Bond, Threadneedle UK Short Dated Corporate Bond and Henderson Secured Loans.
This trend is also shown in the relative performance of the different Investment Association fixed income peer groups.
While they have historically exposed their investors to default risk and larger capital losses, funds within the IA Sterling High Yield sector have outperformed and had a lower maximum drawdown (1.47 per cent) than their rivals in the IA Sterling Corporate Bond and IA UK Gilts sectors, which have had respective maximum drawdowns of 4.53 per cent and 7.1 per cent so far this year.
Performance of sectors in 2015
Source: FE Analytics
Ben Willis, head of research at Whitechurch, says there is one major reason why that has been the case.
“High yield bonds are less rate sensitive, that’s your answer,” Willis said.
“While there is correlation between gilts as high yield bonds are fixed income instruments, when gilts sold-off high yield bonds weren’t as affected because they aren’t as sensitive to interest rates and they are normally more aligned to equity markets.”
“Volatility this year has been due to macro and political events, but mainly people have been focused on interest rates and when the US might start to raise them. It means that anything correlated to government bonds, like investment grade corporate credit, has seen a bigger movement in price.”
“High yield bonds are a bit different as they offer wider spreads.”
Nevertheless, given that yields on junk bonds can no longer be seen as high given the rally in the asset class in the period after the financial crisis (the average IA Sterling High Yield fund has gained 70 per cent over six years), Willis says this trend is unlikely to continue over the long term as he expects big drawdowns from riskier bond funds in the future.
“The main thing we have to focus on in our portfolios is the ‘bond conundrum’ as we have seen equity-like returns from all parts of fixed income over recent years because of emergency interest rates and quantitative easing,” Willis added.
Turning back to the study now and the equity funds with lowest maximum drawdowns this year also focus on the perceived riskiest areas of the market – namely smaller companies.
The fund with the 11th lowest maximum drawdown year to date, for example, is Mark Niznik’s £365m Artemis UK Smaller Companies fund.
According to FE Analytics, the most an investor could have lost in the fund this year is 0.76 per cent. The fund is also narrowly outperforming its peers in the IA UK Smaller Companies sector in 2015, though it is slightly down against its Numis Smaller Companies ex IT benchmark.
Other UK small-cap orientated funds which have given their investors a smooth ride this year include PFS Chelverton UK Equity Growth, Liontrust UK Smaller Companies and Gervais Williams’ CF Miton UK Multi Cap Income.
Again, like in the bond sectors, this trend is shown in the relative performance of small and large-cap equities. Not only has the FTSE Small Cap index doubled the gains of the FTSE 100 this year, it has also had maximum drawdown which is close to four times lower than that of the blue chip index.
Performance of indices in 2015
Source: FE Analytics
“I would put that performance down to two major reasons,” Hawksmoor’s Richard Scott said.
“The first is a technical point as coming into the year small-caps had lagged the broader market. One of the reasons for that is flows into the sector had been negative and a lot of the risks were discounted in prices going into the year.”
“The valuation support meant a lot of people, including us, allocated more to small-caps during tougher market conditions.”
“The other major reason is that a lot of the setbacks which have hit the market this year have been due to more global factors which have affected the likes of natural resources and commodity companies – which the FTSE 100 is more exposed to.”
“Smaller companies, on the other hand, have more exposure to domestic UK where we have seen real wages increasing and the general election result has been viewed as a positive by the market.”
While Scott says there could be short, sharp rallies in the FTSE 100 if investor sentiment becomes more positive about China and other macroeconomic headwinds, valuations support and stronger growth mean small-caps should continue to outperform over the coming year.
Turning the study on its head, the funds which have had the largest maximum drawdowns this year (as the table below shows) mainly focus on gold mining equities – as investors’ appetite for risk has fallen and the gold price is in negative territory year to date.
Source: FE Analytics
However, the likes of Investec Global Gold and WAY Charteris Gold & Precious Metals (which have had maximum drawdowns of more than 25 per cent) are joined by PIMCO GIS Euro Ultra Long Duration Bond – which has been hit massively by the huge spikes in German bunds – and Templeton Asian Growth, which has been overly exposed to the large falls in the Chinese equity market.
