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Have bond funds proved their worth in 2015’s market crash?

19 November 2015

Fixed income has long been held by investors to diversify from equity market volatility, but many are worried it is due a crash.

By Daniel Lanyon,

Senior reporter, FE Trustnet

Investors have been rewarded for holding bond funds over other asset classes through the volatile period since markets crashed on Black Monday, according to research by FE Trustnet.

Bond funds traditional role in a portfolio has been to diversify away equity risk in a portfolio and cushion the impact of any stock market falls, as well as for their income, although the low yields on offer at the moment have caused some to question if this will be case from here.


Performance of bonds and equities over 15 yrs


Source: FE Analytics


Owning a fixed income fund has been a somewhat controversial position in 2015 as many experts have pointed to the risk of a crash followed by a big bond bear market in light of an apparently imminent era of rising interest rates in the UK and US

While yields have been squeezed to near historical lows, in the recent period of market weakness the case can be made that bond funds have performed their diversification role.

According to FE Analytics, the six fixed income sectors in the Investment Association universe have been some of the top places to be invested in the three months since the market lull just before the Black Monday sell-off. These peer groups beat all the equity sectors (aside from IA Technology & Telecoms in some cases).

The IA Global Bond sector is the only peer group where the average fund is up. However, the performance of the average IA UK Gilts, IA Sterling Strategic Bond, IA Sterling High Yield, IA Sterling Corporate Bond and IA Global Emerging Market Bond fund beat any of the equity or mixed asset sectors. The worst performing sector is the IA UK All Companies, being down 4.8 per cent.

Source: FE Analytics


The trend is also noticeable in the wider market with fixed income, as measured by the IBOXX UK Sterling Overall Maturities index, holding strong over this period and having only recently fallen marginally. It is down 0.72 per cent over the past three months while the FTSE All Share is down 3.37 per cent, having had plunged 10 per cent initially.

Performance of  indices over 3 months



Source: FE Analytics

Despite the performance of bond portfolios during this weakness in equity markets, Iboss' Chris Metcalfe (pictured) says it is still not worth holding traditional bond funds regardless of what happens to equity markets in the near term.

“Fixed income has held up well over the past three months or so. We are holding four fixed income funds and two ‘bond proxy’ funds. Over this period equities have twice fallen by about 8 per cent,” he said.

“Our allocation hasn't really changed but the funds we are using has. We don't have a traditional bond line up.” 

Metcalfe says the “asymmetric risk” of fixed income, or the perceived vast imbalance between risk and reward, makes them not worth holding. He thinks the chances of a big sell-off remain while during equity market crashes such as that seen in the past there months bonds tend to be flat at best. 

“We still think the asymmetric risks exists and there is still the potential for quite a lot of downside for bonds. Fixed income has done its job more recently but I still don't think it has been tested. December could be it if the [Federal Reserve] moves,” he said. 

“If you look at the past three months, the best fixed income funds we own has been the Premier Defensive Growth. It has done -0.17 per cent so yes it hasn't lost anything like the drawdown of global equities had but it is not like it has been going up in value.”

Aimed at the risk averse investor, the £332m Premier Defensive Growth fund has been managed by Paul Smith since its launch in December 2010.

The manager focuses on constructing a multi-asset portfolio with the lowest possible risk profile that can generate a positive return over a 12-month period.

It’s made a positive return every calendar year since then, delivering 19.11 per cent overall with a small fraction of the volatility of both equities and bonds.


 

Performance of fund and indices since launch




Source: 
FE Analytics

 Metcalfe thinks instead that cash has a much better risk/reward profile than traditional fixed income markets and says he increasingly attracted by it as an asset class.

“There is a reasonably argument for holding cash, which we have made on several occasions, and cash has returned nothing except for a small amount of charge. Over that three-month period it is close to the performance of where sterling bonds are but you haven't had the risk.”

Chris Iggo, chief investment officer for fixed income at AXA Investment Managers, says despite the relative outperformance of bonds, this year has been a bad one for fixed income broadly and he thinks next year will be not much better

“For bonds it has been the second or third worst year of performance over the last decade. Part of that has been pay-back after a very strong year in 2014 which saw yields and credit spreads fall to very low levels,” he said.

 “I suspect it will be difficult to get great returns from bonds again in 2016. Although yields are a little higher than where they ended last year any additional income return might be lost by a more negative price return, especially in markets where rates go up [in the] US and UK.”

 

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.