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The bond funds that will truly help you sleep at night

14 June 2016

Following the sudden boost in market sentiment surrounding fixed income, FE Trustnet takes a look at the bond funds that have delivered steady and consistent returns over the last decade.

By Lauren Mason,

Reporter, FE Trustnet

The fixed income space has endured a sentiment-driven rollercoaster over the last year or so, with many areas of the sterling-denominated bond market now significantly outperforming the FTSE 100 year-to-date.

Performance of sectors in 2016

 

Source: FE Analytics

This is a far cry from how they fared last year though, due to doubts based on impending rate hikes from the Federal Reserve, the low yields within the asset class caused by ultra-loose monetary policy and an increase in volatility within the bond market, meaning it lost its ‘safe haven’ reputation.

Given that the fixed income market has experienced such sudden swings, investors might be forgiven for fearing that a gruelling bond bear market could be on the cards following the end of the asset class’s 30-year bull run.

In an article published last week, however, FE Invest’s Thomas McMahon said that there is no reason for investors to fear a bond bubble and argues that they still provide important yield and diversification benefits. 

“A bubble is when people are essentially speculating on an asset but are divorced from the fundamentals, so the asset is rising in price and people think there’s going to be a greater fool buying from them, they’re not really looking at the fundamentals of what they’re buying,” he said.

“I absolutely don’t think that’s the case in bond markets at all. I think people are buying bonds on what they view as the fundamentals. Of course, that doesn’t mean they aren’t wrong about those fundamentals or that valuations aren’t high or that certain areas of the bond market aren’t overvalued, but that’s not the same as it being a bubble.”

For those investors who would like to increase their allocation to fixed income funds but are worried about the choppiness of the asset class, FE Trustnet has taken a look at the bond funds that have stable, long-term track records and have delivered steady returns with minimal risk.

To do this, we analysed all areas of the sterling-denominated fixed income market and narrowed them down to the funds that have achieved a first or second-quartile annualised volatility, Sharpe ratio (which measures risk-adjusted returns), maximum drawdown (which measures the most potential money lost if bought and sold at the worst times) and downside risk (which calculates a fund’s potential to suffer a decline in price during negative market conditions) over the last decade.

FE Trustnet also looked at the funds’ total returns on an annualised basis over the last decade and only selected the investment vehicles that had avoided the bottom quartile for their returns during at least eight out of the last 10 years.

With the usual caveat that past performance is no guide to future returns, a total of eight funds remained after these filters were applied. 

One of the standout winners was M&G Strategic Corporate Bond, which has been headed up by FE Alpha Manager Richard Woolnough (pictured) since 2004.

The £4.3bn fund is only one of three out of all those in the sterling-denominated fixed income sectors within the Investment Association that has achieved a top-quartile annualised volatility, Sharpe ratio, maximum drawdown and downside risk ratio over the last decade, while also achieving fewer than two bottom-quartile returns on an annualised basis over the same time frame.

The fund aims to maximise long-term total returns through a combination of both growth and income and does so through holding high-quality, investment-grade bonds. Some of its largest weightings include Lloyds Bank, Imperial Brands Finance and Apple, which are part of a portfolio consisting of 280 holdings.

The fund has an FE Risk score of 23, suggesting that the fund has been less than one-quarter as risky as the FTSE 100 index.


Over the last decade, the fund has provided a total return of 98.86 per cent compared to its sector average’s return of 53.23 per cent.

Performance of fund vs sector over 10yrs

 

Source: FE Analytics

On an annualised basis, the fund is in the top quartile for its performance in 2007, 2008, 2009 and 2011 and is in the second quartile for 2006, 2010, 2013 and 2015. It slipped into the third quartile during 2012 and is in the bottom quartile for its annualised return in 2014, as well as year-to-date. It currently yields 3.23 per cent.

Similarly, M&G Corporate Bond and Fidelity Strategic Bond have achieved top quartile risk metrics across all those we focused on and have avoided the bottom quartile during at least eight out of the last 10 years.

M&G Corporate Bond is also managed by Woolnough and has a similar mandate to M&G Strategic Corporate Bond, although it is able to invest up to 20 per cent of its portfolio in holdings that aren’t high-quality corporates. For instance, the fund currently holds 3.4 per cent in unrated fixed income and 0.1 per cent in CCC-rated credit.

The fund, which has an FE Risk Score of 27, has only fallen into the bottom quartile on an annualised basis in 2012 and has delivered top-quartile performances in 2006, 2007, 2008 and 2011. It is in the second quartile for its performances in 2009, 2014, 2015 and year-to-date and yields 3.47 per cent.

Fidelity Strategic Bond is managed by FE Alpha Manager Ian Spreadbury and has an FE Risk Score of 20. Its focus is more on income than capital growth, although it does aim for growth as well.

The £1.6bn fund, which currently yields 2.82 per cent, provided bottom-quartile annualised returns during 2006 and 2015 and has been in the third quartile three times over the last decade but is in the top quartile for its performances in the bear markets of 2008 and 2011, as well as during 2014 and year-to-date.

Over the last decade, its total return is broadly in line with its BofA ML Sterling Large Cap index and it has outperformed its sector average by 4.02 percentage points with a total return of 27 per cent.

Only two funds that fit the same bill have managed to stay out of the bottom quartile completely for their annualised returns over the last decade – these are the passive L&G All Stocks Gilt Index Trust fund and the Standard Life TM UK Government Bond fund. Unlike the aforementioned funds though, they haven’t achieved a top-quartile score across every risk metric we focused on.

The former, which is £1.1bn in size and tracks the FTSE Actuaries British Government All Stocks index, is in the third quartile during four out of the last 10 years and only achieved a top-quartile annualised performance in 2015 when it provided a return of 0.1 per cent compared to its sector average’s loss of 0.26 per cent.


L&G All Stocks Gilt Index Trust, which has a tracking error of 1.45 over the last decade, has achieved a top-quartile downside risk and annualised volatility over the same time frame and is in the second quartile for its Sharpe ratio and maximum drawdown. The fund has an FE Risk Score of 35 and yields 1.8 per cent.

The latter fund – Standard Life TM UK Government Bond - has been managed by Ian Pizer and Philip Laing since 2005. It has a top-quartile maximum drawdown and Sharpe ratio over the last decade and is in the second quartile for its annualised volatility and downside risk.

In terms of its annualised returns, the £4bn fund is in the top quartile during four out of the last 10 years and only fell into third quartile during 2012 and 2014.

It has provided a total return of 68.55 per cent over the last decade, underperforming its average peer by 2.45 percentage points.

Performance of funds vs sector over 10yrs

 

Source: FE Analytics

The three crown-rated fund yields 2 per cent and has an FE Risk Score of 38.

Other funds that deserve a mention but have both fallen into the second quartile for some risk measurements and have suffered either one or two bottom-quartile annualised returns over the last decade are M&G Gilt and Fixed Interest Income, Fidelity Moneybuilder Income and Schroder UK Corporate Bond.

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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.