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Have strategic bond funds protected investors against rising gilt yields?

22 September 2016

With concerns over the outlook for gilt yields, FE Trustnet highlights the IA Sterling Strategic Bond funds that have had investors’ backs when traditional ‘safe haven’ assets have fallen in value.

By Alex Paget,

News Editor, FE Trustnet

There is a growing concern within the market that yields on UK gilts will continue to rise – though by how much is still debated.

A perennial source of frustration for asset allocators, bonds have consistently defied consensual thinking with yields falling across the board despite the fact that most deem fixed income to have been grossly overvalued.

Indeed, FE data shows that 10-year gilt yields have fallen a hefty 72.14 per cent since January 2014 as economic growth has remain subdued, there has been little sign of inflation and central banks around the world have continued with their extra-loose monetary policies.

That rally has only intensified in 2016 as well. Thanks to macroeconomic concerns at the start of the year, uncertainty in the build up to the EU referendum, a general flight to safety in the aftermath of the Brexit vote and the Bank of England’s decision to reduce interest rates, 10-year gilt yields have dropped another 58 per cent year-to-date.

Performance of 10-year gilt yields in 2016

 

Source: FE Analytics

However, while yields dropped to an historic low of 0.58 per cent in mid-August, they have started to rise in recent weeks and now stand at 0.8 per cent – meaning investors in UK government bonds have been losing money.

The like of Miton’s Anthony Rayner warn that traditional ‘safe haven’ bonds will now act as a source of volatility with prices at such high levels, especially as central banks (who are running out of firepower) are likely to pass the stimulus baton onto governments who may expand fiscal spend.

“Government bond markets are showing some signs of stress, most likely down to confusion as to how supportive central banks are going to be in the future but also the degree to which fiscal policy will impact things like inflation and growth,” Rayner said.

“On a number of occasions recently, bonds have looked like the source of volatility, rather than a safe haven. Whether this ripples out to other asset classes is key.”

Chris Iggo, chief investment officer of fixed Income at AXA IM, agrees that recent weeks have highlighted that government bonds aren’t necessarily the best home for cautious investors given current yield levels.

“Is it more than a wobble?”

“As yet this little episode of bond market jitters can’t really be compared to the “taper tantrum” of 2013 or the “bund shock” of 2015. However, we should not be surprised by these moves given current valuations and the dependence of those valuations on extraordinary central bank policies.”

Of course, there is no way of predicting what will happen to bond yields over the shorter term and it’s also clear that most who have tried to predict the future of fixed income have been way off the market. But, any spikes in yield will hurt investors in the asset class.


Over recent years, a trend within the industry has been for worried fixed income investors to turn to the IA Sterling Strategic Bond sector as managers in the space have a huge amount of flexibility in their portfolios to navigate a potential bear market in the asset class.

Therefore, and with the caveat that the past is no guide to future returns, we looked into which IA Sterling Strategic Bond funds have been able to consistently protect investors when gilt yields have risen (and therefore, gilt prices have dropped).

For the study, we used the FTSE Actuaries UK Conventional Gilts All Stocks index a proxy for gilts and our data shows that nearly all funds with the sector have had a good track record of protecting investors when government bond yields have risen.

The downside capture ratio highlights this as all members of the peer group have had a downside capture ratio of less than 100 per cent relative to the index over five years – showing that the peer group has exposed investors to smaller losses when FTSE Actuaries UK Conventional Gilts All Stocks index has fallen over that time.

IA Sterling Strategic Bond funds with lowest downside capture ratio relative to gilts over 5yrs

 

Source: FE Analytics

In certain instances, though, funds can have negative downside capture ratios (as shown in the table) which indicates that they have tended to make money when an index has fallen in value.

Therefore, FE data shows that many funds within the IA Sterling Strategic Bond sector have been very effective at protecting investors when traditional bond prices have dropped. Indeed, the average downside capture ratio across the top 10 performers in the sector in that respect is -89.93 per cent.

Topping the list is the GAM Star Credit Opportunities fund with a downside capture ratio of -130.09 per cent over five years relative to the FTSE Actuaries UK Conventional Gilts All Stocks index, while Artemis High Income, TwentyFour Dynamic Bond and Royal London Sterling Extra Yield Bond also feature.

All but one of those funds have outperformed the gilt index from a total return perspective over that time as well.


However, while downside capture ratio is a useful metric, it only looks at averages. So, which funds have consistently made investors money when gilt yields have risen?

Performance of index over 5yrs

 

Source: FE Analytics

To analyse this, we looked at the six periods over the past five years when FTSE Actuaries UK Conventional Gilts All Stocks index has posted a drawdown of more than 3 per cent – January 2012 to March 2012, July 2012 to February 2013, May 2013 to December 2013, January 2015 to June 2015 and August 2016 to today’s date which are highlighted in the graph above.

After drilling down further into the data, FE Analytics shows that there are only eight funds that have delivered positive returns in each of those six year periods.

Best performing strategic bond funds when gilts yields have risen

 

Source: FE Analytics

These funds are highlighted in the table above, with GAM Star Credit Opportunities sitting at the top with an average return of 5.88 per cent over those six periods.

Not only has the fund significantly outperformed the gilts over that five year period (which isn’t hugely surprising given its area of focus), it is also one of only two funds on the list to deliver a lower maximum drawdown – the most an investor could have lost if they had bought and sold at the worst possible times – than the FTSE Actuaries UK Conventional Gilts All Stocks index.

The other fund to have achieved that feat is Artemis High Income.

With that in mind, in an article later today we will take a closer look at three of the best performers in this respect that are readily available to investors – GAM Star Credit Opportunities, Artemis High Income and TwentyFour Dynamic Bond – and analyse how they have been able to produce positive returns when traditional safe haven bonds have fallen in value. 

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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.