The IA Sterling Corporate Bond sector has achieved the most consistent top-quartile returns over the last three years, according to research from BMO Global Asset Management, but some industry commentators don’t believe this is set to continue. 
The firm publishes the F&C MM Consistency Ratio, which is worked out by the multimanager team headed by Gary Potter and Rob Burdett and looks at the percentage of funds that have achieved top-quartile returns during each quarter over three-year periods.
In their data running over three years to the end of Q3 2016, it shows that 12.5 per cent of funds in the IA Sterling Corporate Bond sector have achieved this. The IA Global Emerging Markets sector came in second place with 5.2 per cent of funds making the cut and the IA Global Bond sector followed in third place at 4.9 per cent.
At the opposite end of the spectrum, the IA Asia Pacific ex Japan, IA Europe ex UK, IA Japan, IA North America and IA Strategic Bond sectors failed to hold any consistently top-quartile funds at all.
Performance of sector averages over 3yrs to Q3 2016
Source: FE Analytics
In general, 28 out of 1,137 funds in the main sectors of the Investment Association universe (or 2.5 per cent) achieved this feat at the end of 2016’s third quarter, which is at the low end of the historic range of between 2 and 5 per cent.
The team at BMO said: “With five of the 12 sectors failing to have a fund with consistently top-quartile performance for the second quarter in a row it seems that repeatable good performance is as scarce as ever.
“The increasing consistency of IA Sterling Corporate Bond funds coincides with the start of the fall in bond yields around the globe as central banks around the world prop up slowing economies with inflation nowhere to be seen. Meanwhile consistency in core markets such as the UK, US and Europe seems as rare as ever.”
The implementation of ultra-loose monetary policy by central banks has heightened the hunt for yield among investors over recent years, given that holding cash now offers very little return.
As such, many investors have piled into traditionally ‘safe’ fixed income holdings in a bid to secure steady growth and regular pay-outs. This in turn has led to a fall in bond yields, with 10-year gilt yields falling to less than 0.5 per cent earlier this year.
This pattern has begun to reverse slightly over the last month, possibly due to fears of rising inflation and whether central banks are able to continue lowering interest rates. This, combined with the fact yields had been pushed to historic lows, saw 10-year gilt yields rise to around 1.4 per cent, which is where they stand now.
Performance of indices in 2016
Source: FE Analytics
Is this trend set to continue or can sterling corporate bond funds retain their run of strong returns over the next three years?
Mark Dampier, research director at Hargreaves Lansdown, says such consistency in returns is unlikely. However, he says he isn’t “unbelievably bearish” on the sector.
“Interest rates are at rock bottom and also, you’re not going to get any more interest rate cuts so you might say that whole thing has played out,” he reasoned.
“Given what’s happened in markets over the last couple of weeks, maybe we’re seeing that because a lot has been given back over the last couple of weeks, particularly over the last few days.
“That said, I don’t think interest rates are going to go up and that’s why I’ve been keener on corporate bonds and fixed interest than most others because I’ve never thought interest rates are going to rise and I don’t think they’re going to rise for quite some time yet, either.
“What you’ve got is quite a volatile instrument, though. They’re all fed off of gilt yields ultimately and 10-year gilt yields have gone from half a per cent to about 1.4 per cent [and] could go up to 2.5.”
Dampier points out that 10-year gilt yields have varied between 0.5 per cent and almost 3 per cent over the last five years or so. While he says this may not seem like much, he warns would have been enough to significantly hurt investors had they bought in when yields were at 0.5 per cent and sold when they were near 3 per cent.
“Especially since the election of Trump, people have been suggesting that there’ll be huge reflation in the US. Well, there might be, but actually nobody really knows at the moment,” he continued.
“I don’t think that is likely to be repeated over the next three years, I find that slightly hard to see them doing quite as well as they have been, but I’m not sure they’ll be the worst-performing sector just yet.”
Adrian Lowcock, investment director at Architas, says it will “certainly be much tougher” to make money out of the sector given how low interest rates are already. He says its outperformance can partially be attributed to the stimulus the Bank of England announced in August, which included buying £10bn worth of corporate bonds over 18 months.
“It’s interesting timing-wise. I think it’s an area that has done quite well in terms of the monetary policy that the Bank of England has announced and, even though the headline figure of how much they said they were going to buy seems quite small, it’s quite a tight market in terms of volume,” he said.
“Bond purchases in the corporate bond sector from the Bank of England are going to continue to have an impact on that sector.
“I guess one of the challenges going forward is whether we’ve reached the bottom of bonds generally and that is going to be led by gilts. If gilt yields start to rise then you’d expect corporate bond yields to start rising as well, which would have an impact on the capital value.”
For those who still want some exposure to the sector, Lowcock says FE Alpha Manager Ian Spreadbury’s Fidelity Moneybuilder Income fund could be a good option.
Over five years, the £4bn fund has returned 32.51 per cent compared to its sector average’s return of 33.59 per cent and its BofA ML Euro-Sterling benchmark’s return of 39.63 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
That said, it has outperformed its average peer over one, three and 10 years. On a yearly basis, it has retained a position in the top or second quartile over seven of the last 10 years, falling into the third quartile in 2015 and in the bottom quartile in 2012 and 2013.
It has a top-quartile annualised volatility, maximum drawdown (which measures the most money lost if bought and sold at the worst times) and downside risk (which predicts susceptibility to fall during negative market conditions) over the last decade.
“Fidelity Moneybuilder Income fund which is quite cautiously-managed,” Lowcock explained. “Ian Spreadbury is good at managing the risk on that and it has been quite defensively positioned, he doesn’t want to put too many risks in his portfolio, so that’s probably a good one to hold in this space of time.”
Another fund in the sector that the investment director likes is Invesco Perpetual Corporate Bond, which has been managed by Paul Read and Paul Causer since 1995. Over 10 years, it is in the second quartile for its downside risk, maximum drawdown and annualised volatility.
Over the same time frame, it has fallen into the bottom quartile for its annual returns three times – in 2011, 2014 and year-to-date, and was in the third quartile for its returns in 2010. Overall though, it has outperformed its average peer by 14.72 percentage points over the last decade with a 67.52 per cent total return.
“With Invesco perpetual Corporate Bond you have an experienced team in Paul Read and Paul Causer. They tend to be a bit early when it comes to calling tactical or strategic ideas which means they can sometimes lag,” Lowcock added.