Less than 14 per cent of sterling bond funds that have a 10-year track record and are benchmarked against an index have outperformed over the last decade, according to the latest FE Trustnet study.
The research consists of funds in the IA Sterling Corporate Bond, IA Sterling Strategic Bond and IA UK Gilts sectors – while we ran the data for the IA Sterling High Yield sector, it transpired that only one fund had a 10-year track record and was benchmarked against an index that we had the data for.
Source: FE Analytics
Bond funds are often benchmarked against their sector average as opposed to an index to allow the managers greater flexibility in terms of investment choices. The bond universe is far bigger than the equity universe and as such, there are many more indices to choose from and it is less clear-cut in terms of which index a fund should be pitted against.
However, those that are benchmarked against an index have delivered comparatively paltry returns. The IA Sterling Corporate Bond sector has the greatest number of bonds that are benchmarked against indices – out of 59 funds with a 10-year track record, 31 of them are benchmarked against an index.
According to our data only six of these funds have beaten their benchmarks – these were SVS Church House Investment Grade Fixed Interest, Schroder Long Dated Corporate Bond, Schroder All Maturities Corporate Bond, Pimco GIS UK Long Term Corporate Bond, Newton Long Corporate Bond and Morgan Stanley Sterling Corporate Bond.
This means that only 19.35 per cent of funds in the sector with the necessary criteria have beaten their benchmark over 10 years.
Not only did we decipher which funds outperformed or underperformed their indices, we took a note of the index that was most common in each sector. In the IA Sterling Corporate Bond sector, the Bofa ML Sterling Non-Gilts index was used the most. Over 10 years, it has returned 68.62 per cent, compared to the UK corporate sector average return of 45.97 per cent.
Out of 30 funds in the IA UK Gilts sector, 20 of them have a track record of more than 10 years. Only nine of the funds are then benchmarked against an index that we have access to, and not a single one of them managed to beat their benchmark.
The index that was used the most was the FTSE Gilts All Stocks, which has returned 68.8 per cent compared to the sector average’s return of 57.87 per cent.
Performance of index vs sector over 10yrs
Source: FE Analytics
Over in the IA Strategic Bond sector, the only fund that managed to beat its index was Fidelity Strategic Bond, which has been managed by FE Alpha Manager Ian Spreadbury since its launch in April 2005.
Over the last decade, the £1.6bn fund has outperformed its BofA Merrill Lynch Sterling Large Cap index by 4.12 percentage points, providing a total return of 71.19 per cent.
The most common index used by the funds though, which was BofA ML Sterling Broad Market, has returned 66.73 per cent over the last decade, outperforming the IA Sterling Strategic Bond sector average by 18.15 percentage points.
Performance of sector vs index over 10yrs
Source: FE Analytics
Ryan Hughes, fund manager at Apollo Multi Asset Management, has been vocal since the start of the year about the problems he foresees in the fixed interest market and believes that many managers are ill-prepared for the future given we are entering a rate rise environment.
As such, he says that FE Trustnet’s data emphasises this need for very careful management selection, not just in fixed income sectors but across any asset class.
“Over the past 10 years we have seen the extremes of market conditions that included the near collapse of the financial system when many bond managers were caught out combined with the strongest bull market in bond history with yields falling to record lows and in some cases moving into negative territory,” the manager said.
“This environment has clearly tested all fund managers and your data highlights just how hard it is for managers to consistently outperform over long periods of time. Those that have delivered over such a long period of time should be lauded.”
The research could also throw up questions as to whether fixed income investors should turn to trackers to generate returns, seeing as actively-managed funds have found it so difficult to beat their benchmarks.
Ben Gutteridge, head of fund research at Brewin Dolphin, believes any fears that duration has lost its hedging capability are misguided and that, in the face of an economic downturn or a sell-off, he would buy into developed market sovereign bonds through a tracker such as Vanguard Global Bond Index.
“The softer growth outlook and general level of indebtedness will render any normalisation process as extremely slow. Terminal interest rates will also be lower in this cycle and so, even if the optimistic base case plays out, we do not expect to make any meaningful losses in government bonds,” he said.
“The Vanguard Global Bond Index fund has an added appeal because of its global allocations and significant dollar exposure; a currency we expect to remain strong.”
Performance of fund versus sector since launch
Source: FE Analytics
Mike Deverell, partner and investment manager at Equilibrium, says the fact we have been in a long bull run for bonds has made it harder to beat the index.
“We tend to find that active funds are less likely to outperform in a bull run, even in equities. In bond markets this is perhaps more pronounced since returns tend to be lower and charges therefore have a bigger impact. Spreads are also wider than for equities so funds with high turnover get hit with high trading costs,” he explained.
“My concern is what happens in a bear market. Bond indices are market cap weighted in a similar way to equity indices. However, what that means is that you allocate most to the companies with the most debt. If we see more difficult times for bonds, especially if we start to see defaults, then I would not want to be holding an index fund.”
Hughes believes that FE Trustnet’s data shows that investors shouldn’t be investing in fixed interest trackers because, if an investors believes the bond market is inefficient, active managers provide a greater chance of producing high returns through alpha generation.
“The key is to find managers who are experienced, have delivered in different market conditions, and crucially are prepared to invest away from the benchmark. If we are entering a bond bear market, the only way to outperform the index is to invest differently to it,” he said.
Jason Hollands, managing director at Tilney Bestinvest, says it is important to remember that 100 per cent of trackers will have underperformed their market indices and 0 per cent will have outperformed and that ultimately, the data is a by-product of distortions caused by abnormal monetary policy from central banks recently.
“It is important to remember that (most) bonds have a fixed life, at the end of which the bond will be redeemed at the value originally issued. And investors either buy bonds for income, or to reduce overall portfolio volatility,” he said.
“So, bond fund managers are absolutely focused on achieving income-yield and avoiding capital losses, rather than chasing distortions caused by central banks.”
He adds that many bond fund managers are understandably cautious at the moment, so have positioned their portfolios in favour of short duration stocks as a defensive measure.
“In this environment, investors who don’t have an index weighting to distorted long-dated bonds are likely to have ‘underperformed’,” he added.
