The outlook for fixed income is increasingly uncertain. While some have positioned for another rally in the asset class due to global deflationary forces and weaker-than-expected economic growth, others are very bearish on bonds given that yields on gilts and treasuries are already low and mathematically can’t go much lower.
It has also been another rollercoaster ride for bond investors in 2015, as yields spiked aggressively earlier in the year (causing uncharacteristically large drawdowns) only to fall over recent months as equity markets corrected.
Performance of indices in 2015
Source: FE Analytics
With uncertainty rife over the economy and the future of interest rates, most investors are now advised to stick their cash in IA Sterling Strategic Bond funds as the managers can invest anywhere across the fixed income markets and can even buy equities.
Therefore, with the caveat that the past is no guide to the future, FE Trustnet looked back to see which funds have managed to comfortably outperform over the market cycle, but have done so with the lowest maximum drawdown – which calculates the most an investor would have lost if they had bought and sold at the worst possible times – and the highest risk-adjusted returns (as measured by their Sharpe ratios).
For the purposes of this study, we have measured the market cycle as an eight-year time frame as it takes into account the build-up to the financial crisis, the crash itself, the subsequent bull market and the recent wobbles.
Over that time frame there are three top-rated funds which stand out – one of which is the £1.6bn Fidelity Strategic Bond fund, headed-up by FE Alpha Manager ‘hall of famer’ Ian Spreadbury.
According to FE Analytics, the fund has been the fourth best performing portfolio in the sector over that time with returns of 70.46 per cent, meaning it has beaten the peer group average by more than 25 percentage points.
Performance of fund versus sector over 8yrs
Source: FE Analytics
Better still, it has had the third best Sharpe ratio and a maximum drawdown of just 7.42 per cent – an impressive feat given that more than 40 per cent of Spreadbury’s peers have had a maximum drawdown of 25 per cent or greater over that time.
Fidelity Strategic Bond has tended to lag in strongly rising markets, such as 2009 and 2012, but was able to lose just 0.29 per cent in 2008 when the sector fell 13 per cent.
However, the fund has been hurt during the recent volatility as it is behind the sector so far this year with a loss of 0.46 per cent and has been third quartile for its maximum drawdown. In fact, it is down more than 4 per cent since April.
Thomas McMahon, fund analyst at FE Research, says the fund’s performance over the longer term stems from Spreadbury’s bearish outlook as he kept duration higher than most of his peers, meaning he has benefitted from bouts of negative sentiment.
He points out, however, that positioning hurt the fund this year as longer duration assets corrected significantly.
“However, Spreadbury believes that a bond fund should retain sensitivity to the major risk factors of bonds as this is what gives them a distinct return profile from equities and allows them to do their job of protecting capital when equity markets fall,” McMahon said.
“So short-term moves such as these are unlikely to worry him – in fact the duration on the fund has increased slightly in recent months. Spreadbury thinks the level of debt in the world economy will limit growth, inflation and interest rates for many years to come, which justifies maintaining a higher weighting to defensive sectors and companies of good credit quality.”
“The high yield weighting has also been coming down this year and the fund has large allocations to liquid corporate bonds of high credit quality and government bonds from a number of issuers.”
Another fund to have come out well from this study is £18.3bn M&G Optimal Income portfolio, which is run by Richard Woolnough who is also an FE Alpha Manager ‘hall of famer’. 
M&G Optimal Income currently occupies the sector’s third spot over eight years as its returns of 82.36 per cent are nearly double those of its average peer. While its maximum drawdown is slightly higher than the Fidelity fund’s at 11.31 per cent, it is still top quartile in that respect and has delivered the second best risk-adjusted returns in the sector.
Woolnough (pictured) is very highly rated within the industry and this is, in part, due to the consistency of his returns. For example, M&G Optimal Income has beaten the sector in six out of the last eight calendar years, including both rising and falling markets.
There have been a number of developments regarding the fund which may have made some investors anxious, though.
Firstly, while concerns have been raised about the size of the fund for a number of years, these have seemingly come to a head over recent months as its AUM has shrunk by 25 per cent since its peak in January.
That figure includes capital losses, but FE data shows it has been the most sold fund in the Investment Association universe over the past six months as a whopping £4.7bn has been redeemed from the portfolio.
Performance of fund versus sector over 1yr
Source: FE Analytics
Though the fund’s positioning (low duration exposure and a belief the global economy is in a better place than most believe) has driven the fund’s relative performance recently, those outflows will have certainly contributed to M&G Optimal Income’s bottom quartile losses over the past 12 months.
The final portfolio on the list is the £1.1bn L&G Dynamic Bond fund, which has been the best performer out of the three over eight years with gains of 91.25 per cent. It has had a maximum drawdown of 10.27 per cent and the sector’s highest Sharpe ratio over that time.
For most of this period the portfolio was headed up by Dickie Hodges, who had been one of the most vocal bears about the prospect for bonds and was running very low duration as a result. Hodges left L&G in April 2014 and now runs the Nomura Global Dynamic Bond fund.
The portfolio is now headed up by Omar Saeed, who has upped the fund’s exposure to high yield.
Since Hodges left L&G, the fund (which was managed by Martin Reeves on a temporary basis before Saeed to charge) has been a third quartile performer with returns of 1.46 per cent.
Performance of fund versus sector since Hodges’ departure
Source: FE Analytics
As the graph above shows, it has also been one of the most volatile in the sector over that time, but the new managers have had to deal with significant outflows as the portfolio’s AUM is some 45 per cent smaller than it was when Hodges was at the helm.
While it doesn’t have the longest of track records, TwentyFour’s Focus Bond fund has been the best in the sector at preserving capital over recent years.
The five crown-rated fund has had the lowest maximum drawdown in the peer group over three years at just 2.39 per cent and the fourth best Sharpe ratio but has been top decile for returns with gains of 24 per cent.
PFS Focus Bond invests in high yield, investment grade, government bonds, asset-backed securities and more niche areas but with the caveat that the majority of the holdings in the portfolio are due to mature within the next three to five years.
