Strategic bonds better than corporates, argues Chelsea's McDermott

More than a third of Cofunds second-quarter net sales were into IMA bond fund sectors but Sterling corporate bonds sales have fallen have fallen back from 39 per cent in the first quarter of this year to 36.8 per cent, with the cautious managed sector the main beneficiary of the fall in bond sales.

Cofunds notes that cautious managed, which picked up 15.5 per cent of sales in the second quarter, doubled in popularity compared to first quarter when it picked up 7 per cent of sales.
 
Although the sector has been popular over the last two years it had fallen back over the last nine months. Popular cautious managed funds included the Invesco Perpetual Distribution although it did not make it into the top twenty best sellers.

Darius McDermott, managing director at Chelsea Financial Services, commented that while bond funds remain popular among this company’s clients they favour strategic bond funds rather than corporate bonds. He said he prefers strategic bond funds because the mandate allows the manager to invest in a wider range of bonds than corporate bond funds, although this makes strategic funds higher risk.

It also means the manager, who can access a wider range of bonds, allocates rather than the client. In addition, if inflation returns as a result of quantitative easing, strategic bond funds have more flexibility to invest in resilient areas such as high yield or index linked gilts whereas as corporate bond funds could lose value due to their restricted mandate.

However, McDermott added that as there is no immediate threat that interest rates will rise with inflation falling below target for the first time in nearly two years, hitting 1.8 per cent in June. He said for this reason bond funds will continue to attract interest as they are among the best performing sectors, offer greater certainty than equities and investors need income while interest rates are so low.

But he added that if there is an equity market rally bond popularity will decline. Cofunds business development manager Michelle Woodburn added that market sentiment is helping bond sectors but that investors are already starting to look at ‘recovery’ areas such as North America which accounted for 2.9 per cent of net sales in the second quarter, and is likely to be stronger again in the third quarter.

Another reason why McDermott prefers strategic bond funds is because they are smaller and nimbler than corporate bond funds. For example, Invesco Perpetual Corporate Bond fund has £4.197bn assets under management while M&G Corporate Bond has £3.499bn, in contrast to Invesco Perpetual Monthly Income Plus which has £2.071bn under management, and M&G Optimal Income fund with £720.2m under management.

Other strategic bond funds McDermott favours include Henderson Strategic Bond and L&G Dynamic Bond.

Sterling Strategic Bond funds accounted for only 2.9 per cent of Cofunds’ second quarter net sales, albeit one of the top ten selling sectors. However, a fund from this sector did make it into the top 20 – M&G Optimal Income was the eighth best seller.