Our data shows that on average, a Corporate Bond fund that is yielding more than 5 per cent has 46 per cent in BBB rated bonds or lower. The three-crown rated Rathbone Ethical Bond fund, the highest yielding fund in the sector, is currently holding 51 per cent in BBB rated bonds or lower, including 10 per cent in sub-investment grade paper.
The £93.3m Rathbone portfolio, managed by Bryn Jones, is currently yielding 6.7 per cent – well above the sector average of 4.55 per cent. According to FE data, the fund’s exposure to BBB-rated debt has increased from 10.5 per cent in March 2011 to 15.75 per cent at the end of last month. The £230.3m Alliance Trust Monthly Income Bond fund is another high yielding fund, at 5.52 per cent.
Managers Gareth Quantrill and Stuart Steven have allocated almost exactly half their portfolio to BBB-rated debt or lower. The fund, which was launched in June 2010, has delivered top-quartile returns since launch, but at significantly higher volatility than the sector. The Rathbone portfolio has also been more volatile than its sector over the short, medium and long-term.
FE Trustnet recently looked into high-profile bond funds which are delivering yields of less than 3 per cent, including Richard Woolnough’s flagship £6.5bn M&G Corporate Bond and £5.7bn M&G Strategic Corporate Bond funds.
The funds are currently holding a negligible weighting in sub-BBB rated bonds, and are heavily tipped toward high-quality investment grade paper, holding roughly 10 per cent less in BBB rated bonds than some of the highest yielding funds in the sector.
Darius McDer
mott (pictured right), managing director of Chelsea Financial Services, says some managers have no choice but to look into ‘riskier’ bonds in order to maintain higher yield levels. “It’s increasingly difficult to get the yield because yields on quality paper, such as government bonds, are negligible,” he said.
“Yield is part of a bond funds’ return, but managers like M&G aren’t going to do it at what they think is undue risk to get the yield.”
McDermott says it's perfectly reasonable for bond managers to hold a significant proportion of their holdings in sub-investment grade debt, as long as the move is in line with the fund objective.
“I’d like to think managers with BBB and lower are doing it because that’s where they think from an investment point of view they should be,” he said.
Rob Gleeson (pictured left), head of FE Research, says there are two main factors that influence a bond managers’ decision to increase their risk-exposure.
“Firstly, managers who fear inflation are having to compensate for the fact that their predictions aren’t being priced into current yields, and are hedging their portfolios as a result,” he said.
“However, I also think we are seeing a shift from fear to greed, as capital preservation is becoming less important and some managers are again willing to take more risk to secure returns.”