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Why you’d be wrong to ditch your bond funds

11 September 2013

A scenario in which the global recovery falters and interest rates are kept at their current levels is still a real possibility, according to FE Research’s Rob Gleeson.

By Alex Paget,

Reporter, FE Trustnet

Investors would be foolish to give up on fixed income funds, according to FE’s Rob Gleeson, who says he has maintained a high allocation to bonds in the recent rebalancing of FE Research’s model portfolios.

ALT_TAG Concerns over the bond market have gathered pace recently, with many market commentators saying the asset class is coming to the end of a multi-decade bubble.

With the global economic recovery apparently in full-flow and the tapering of quantitative easing on the horizon, bondholders could well suffer at the hands of rising yields in the coming months.

Gleeson, head of research at FE, admits that though fixed income funds could hinder portfolio performance in the short-term, he believes there is enough uncertainty to warrant exposure to the bond market.

"The reason why we have kept our allocation to bond funds is for purposes of diversification," Gleeson explained.

"Yes, there is the future scenario where the economy recovers and interest rates go up, which would mean the capital value of bonds would fall. However, the other scenario is that the recovery doesn’t take hold and that fears of the end of QE and rising interest rates disappear."

"In that environment, bond values would rise."

"We don’t know which scenario will play out but we can’t have all the portfolios in equities, because we would be shafted. We have to have a range of asset classes. I fully except that our bond funds could well be a drag on performance, but that doesn’t matter."

"The point is that we cannot predict the future, so we need to be diversified," Gleeson added.

He says that there are so many areas of fixed interest that he is light on, but he expects that no matter how tough the outlook may be, there are managers who will still be able to make money out of bonds.

"In some of the portfolios, eValue have told us they see no value in gilts, so we have cut our allocation. But we have still kept strategic bond funds," Gleeson said.

"That is because for low-risk investors, they just cannot be fully invested in equities. There is also still some value in bonds, but even the income paid out from bonds should offset a fall in their capital values."

"People forget that you can just hold a bond till maturity as well."

"Bond managers are well aware of the headwinds facing the market and there are still a lot of strategic bond managers who are confident in their ability to run money in a tougher environment."

"They will be like the headwinds that equities have faced in the past, but there have been a lot of equity managers who have been able to make money in those conditions," he added.

As Gleeson points out, the last few years since the financial crash have not exactly been a breeding ground for equity investment.

Despite the fact there has been little economic growth and a huge amount of deleveraging on the part of both corporates and consumers, funds such as Fidelity UK Smaller Companies, Unicorn UK Income and Standard Life UK Equity Unconstrained have delivered very high returns.

Performance of funds over 5yrs


Source: FE Analytics

Gleeson’s final point is that investors need to remember that they can never attempt to capture 100 per cent of the upside when it comes to creating a diversified portfolio.

"The main thing is that rising bonds are now very predictable, so a lot of that is now in the price and managers have had time to plan for it," he said.

"Bonds will definitely face a difficult time at points in the future, but you don’t want all your investments going up at the same time. If that were to happen, then I would be worried because chances are they will all fall at the same time as well."

"Also, bonds and equities have been highly correlated for the last two years, but we are getting towards more normal market conditions where good news for equities means bad news for bonds and vice versa."

"That means that the reason for holding bonds is now more important than it has been recently," he added.

Two of the funds that Gleeson favours are FE Alpha Manager Stewart Cowley’s Old Mutual Global Strategic Bond and the five crown-rated M&G Global Macro Bond – the former being a new entrant to the FE Select 100.

"The reasons we like those funds are because the managers have a wider investment range and have more flexibility than others," Gleeson added.

According to FE Analytics, both fixed income portfolios have comfortably beaten the average fund in the IMA Global Bonds sector over the last 10 years – however both funds currently yield around 1 per cent.

Performance of funds vs sector over 10yrs


Source: FE Analytics

The £850m M&G Global Macro Bond has an ongoing charges figure (OCF) of 1.41 per cent and requires a minimum investment of £500, while the Old Mutual fund is slightly cheaper with an OCF of 1.12 per cent, but requires a minimum investment of £1,000.

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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.