After a great run over 30 years, and an especially good period since the financial crisis, bonds are regarded as an asset class in decline by many fund managers, who are constantly looking at ways to capture yield elsewhere.
However, some industry professionals have called on investors to reassess their attitude towards bonds in recent weeks.
TwentyFour Asset Management’s Mark Holman believes the whole concept of a bond bubble is completely flawed, and more recently Hargreaves Lansdown’s Mark Dampier argued that the investment climate will ensure that yields stay low for some time to come.
With this in mind, FE Trustnet takes a closer look at some top-performing bond funds that score highly across FE’s three main rating systems: FE Crown Fund Ratings, which highlight excellent funds; the FE Alpha Manager rating, which highlights excellent managers; and finally the FE AFI portfolios, which reflect the views and opinions of leading industry experts.
Jupiter Strategic Bond
- FE Crowns: 5
- FE Alpha Manager: Yes
- AFI portfolios: Cautious, Balanced, Aggressive
The five crown-rated fund has been headed up by FE Alpha Manager Bezalel since its launch in 2008, and appears in all three of the AFI’s recommended portfolios.
One look at the performance tables and it is easy to see why: the manager has led the Strategic Bond fund to the top decile of its sector since launch, with returns of 70.57 per cent. This is just under twice as much as the sector average.
Performance of fund vs sector and index since launch
Source: FE Analytics
It has also comfortably beaten its benchmark – the Iboxx Non-Gilts All Maturities index – over the period, albeit with more volatility, and is a top-quartile performer over three years as well.
Bezalel (pictured) is not constrained by any benchmark and can invest in a range of bonds, including the government and non-rated corporate types.
He combines his assessment of the economic environment with company analysis to identify areas of the fixed income market that he feels are undervalued.
The FE Research team rates Jupiter Strategic Bond highly, highlighting the fact that Bezalel is a stockpicker, which allows him to add more value than many of his competitors.
"Bezalel likes to target companies that are in the process of improving their financial health, as their bonds offer the best potential returns," he said.
"The manager also enjoys investing in 'out-of-the-box' niche positions that are not followed by mainstream fixed income investors."
Among the manager’s top-10 positions at the moment are three options on Australian government debt, and a 7.2 per cent coupon on Punch Taverns, which matures in 2022.
The fund is invested predominantly in B, BB and BBB rated debt, which has allowed him to keep his yield at a competitive level. According to FE data, it is currently paying out 5.6 per cent, which is well above average for the Strategic Bond sector.
The manager has very little in financials, preferring to get higher yields from areas that are less reliant on the fate of the eurozone.
FE Research sees Bezalel as genuinely unconstrained, unlike some of the other strategic bond managers who have a fixed mandate.
"Bezalel has taken full advantage of his unconstrained mandate," the team explained.
"By varying the portfolio’s allocation to government bonds or high- or low-rated corporate bonds according to his assessment of the economy, he has generated outstanding performance since the fund’s inception."
"The fund is a good choice for an investor with no strong feelings about bonds and who wishes to outsource responsibility for this asset class entirely."
Jupiter Strategic Bond requires a minimum investment of £1,000 and has an ongoing charges fee (OCF) of 1.5 per cent.
FE Alpha Manager David Coombs recently expressed some concerns about the growing size of the fund, which Bezalel strongly countered in a recent FE Trustnet article.
Threadneedle Dollar Bond
- FE Crowns: 4
- FE Alpha Manager: No
- AFI portfolios: Cautious, Balanced, Aggressive
As the name suggests, Threadneedle Dollar Bond invests in dollar-denominated debt. It invests in both US government and corporate bonds. As long as the company issues its bonds in dollars, these corporate bonds can include those not listed in the US.
Manager David Oliphant is currently bearish on gilts, preferring to take on a greater degree of risk in the higher-yielding corporate debt market. Banks, consumer goods, and oil and gas are all major sector positions.
Oliphant has run the fund since 1998, but it is only in the last five years or so that it has performed strongly on both an absolute and relative basis.
The four crown-rated fund did well during the financial crisis, which has helped it push in to the top quartile of its sector over a five-year period.
Performance of fund vs sector over 5yrs
Source: FE Analytics
FE does not have access to the fund’s composite benchmark. By means of comparison, the Merrill Lynch Corporate Master Index and Merrill Lynch Treasury Master Index have returned 45.99 and 25.77 per cent over the period, respectively.
The fund has also outperformed the sector average over one and three years, albeit with more volatility.
The FE Research team rates Oliphant and recommends investors look at Threadneedle Dollar Bond as a possible alternative to out-of-favour gilt funds.
"Oliphant has showed a high degree of skill in selecting the right issuer, an example of this being his remarkable decision to invest large amounts in fixed interest securities issued by certain US retail banks [during the financial crisis]," the team said.
"Threadneedle Dollar Bond may prove difficult to fit into investors’ portfolios and is best viewed as a source of diversification and as an alternative to gilts."
The fund requires a minimum investment of £2,000 and has an OCF of 1.24 per cent.
Oliphant’s long-term record is not strong enough to qualify for FE Alpha Manager status, but his fund is included in all three AFI portfolios.
Kames High Yield
- FE Crowns: 3
- FE Alpha Manager: Yes
- AFI portfolios: Cautious, Balanced, Aggressive
It is co-managed by Philip Milburn and FE Alpha Manager Melanie Mitchell. Milburn has headed it up since 2003, with Mitchell joining him in 2011.
The managers can hold the high yield debt of companies listed anywhere in the developed world, although in practice most of these tend to be based in the UK.
High yield bonds are issued by companies whose credit rating is below what is considered acceptable for the most cautious institutions, such as insurers and pension funds, but typically pay a higher rate of return.
As such the market tends to scrutinise them less thoroughly and Milburn and Mitchell believe they can add value through in-depth analysis. The FE Research team says they have done this successfully.
It is the only fund in IMA Sterling High Yield to feature in the FE Select 100. The team likes the fund’s defensive bias, strong total return record, and attractive yield, which is currently at around 6 per cent.
"This fund has a relatively unusual strategy in that it focuses on the selection of individual bonds instead of trying to call economic factors such as interest rates, which is the approach taken by the majority of its peers," the team said.
"This may have initially been due to Milburn’s background in equities, but it has since become part of the fund’s DNA and would likely survive his departure."
"The fund’s bias towards defensive companies has caused it to lag slightly when the market has rallied, but it has still done reasonably well overall."
Performance of fund vs sector over 10yrs
| Name | 1yr (%) | 3yr (%) | 5yr (%) | 10yr (%) |
|---|---|---|---|---|
| Kames High Yield Bond | 10.97 | 29.24 | 62.23 | 124.16 |
| IMA Sterling High Yield | 12.57 | 23.57 | 50.2 | 103.8 |
Source: FE Analytics
The fund has consistently beaten its IMA Sterling High Yield sector over the last decade. It has fallen short of its Barclays Global High Yield benchmark however, but it has been less volatile.
The only FE rating where the fund falls down is its FE Crown rating, which is currently three out of a possible five. This is down to its slight underperformance versus its sector at the time of the rebalancing, although it has improved since then.
Kames High Yield requires a minimum investment of £500 and has an OCF of 1.3 per cent.