Yields have been falling on the bond market and investors have been urged to go to higher-yielding bonds or higher-risk equities for their income.
However, many investors remain cautious and are reluctant to take on too much extra risk.
Strategic bond funds – which have the ability to invest in all parts of the bond market – are a reasonable compromise for such investors, and fund-flows data shows that the popularity of this sector has continued to soar ahead of the more specialised corporate and high-yield ones.
Here we look at the funds that have consistently added value to the market over the past five years, through up- and down-markets.
FE Alpha Manager Richard Hodges’ £1.7bn L&G Dynamic Bond fund has added the most value to its benchmark over the past five years, at 5.4 per cent, despite a dip in performance in 2011.
The portfolio takes the average fund in the sector as its point of comparison, but switching this for the iBoxx Sterling Overall All-Mats benchmark of UK government and corporate bonds produces an even more impressive figure: 9.15 per cent.
Hodges made his name by outperforming the sector during the crash of 2008 and in the rebound of 2009, when he made the right calls on the effect of the failing market on bonds.
Data from FE Analytics shows his fund has the best performance figures in the IMA Sterling Strategic Bond sector over five years, at 73.15 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
However, the fund sits in the fourth quartile over three years, thanks to a poor 2011.
Charles Younes, research analyst at FE, rates the fund highly, and says that Hodges and his team have usually made the correct macro calls.
However, he added: "Unfortunately they got it badly wrong in 2011 when they misjudged the trajectory of US interest rates. This mistake had a massive impact on performance."
Younes explains that Hodges is now positioning his fund for an interest rate hike in 2015, buying short-maturity bonds that will expire around that time.
The analyst says it is a low-risk strategy with a potentially high trade-off.
Hodges' fund is currently yielding 4.4 per cent, significantly more than the 2.72 per cent paid out by the second fund on the list, M&G Optimal Income.
This £13.4bn fund has received the bulk of the inflows into the sector in recent months.
Data from FE Analytics shows that it has received more than £4bn in new inflows over the past year, roughly eight times the inflows seen by the next most popular fund.
The fund has outperformed Hodges’ over the past three years, which may explain its relative popularity.
It has made 28.7 per cent over this time while the average fund in the sector has returned 21.98 per cent.
Performance of fund vs sector over 3yrs
Source: FE Analytics
However, over the longer timeframe, the L&G fund has superior returns and alpha.
M&G Optimal Income, which is run by Richard Woolnough, has added alpha worth 5.03 per cent a year over the past five years.
If it is compared to the iBoxx Sterling Overall All-Mats benchmark, it has added alpha worth 8.94 per cent a year, still in second place.
The £1.4bn Fidelity Strategic Bond fund, managed by FE Alpha Manager Ian Spreadbury, is third on the list, having added annualised alpha worth 4.69 per cent to its index over the past five years.
Like with Woolnough’s fund, the yield on Spreadbury’s portfolio has been falling, and is now at 2.94 per cent, according to our data.
Against the iBoxx benchmark of UK sovereign and corporate bonds, it slips down the table.
Its alpha over this benchmark is 4.65 per cent a year, behind both the Cazenove Strategic Bond and Fidelity Extra Income funds, which also appear on this list.
Annualised alpha of strategic bond funds over 5yrs
| Name | Alpha |
|---|---|
| L&G Dynamic Bond | 5.4 |
| M&G Optimal Income | 5.03 |
| Fidelity Strategic Bond | 4.69 |
| Ecclesiastical Amity Sterling Bond | 3.38 |
| UBS Active Bond | 2.54 |
| Virgin Income | 2.39 |
| NFU Mutual Gilt & Corporate Bond | 2.11 |
| Investec Strategic Bond | 1.9 |
| Fidelity Extra Income | 1.76 |
| Cazenove Strategic Bond | 1.32 |
Source: FE Analytics
All three multi-billion pound funds are currently yielding significantly less than the 5.24 per cent paid out by Ecclesiastical Amity Sterling Bond, the fourth fund on our list.
FE Alpha Manager Robin Hepworth’s £57m fund is nowhere near the size of Hodges’, Woolnough’s or Spreadbury’s, and receives little attention from analysts or investors.
However, our data shows that the fund, which Hepworth runs with Chris Hiorns, has added alpha worth 3.38 per cent to its benchmark.
The managers took over the fund in March 2008. The fund is a top-quartile performer over the past five years, with returns of 45.31 per cent against a sector average of 37.36 per cent.
The highest-yielding fund on the list is the Cazenove Strategic Bond fund, currently yielding 6 per cent, according to our data.
Another less well-known fund on the list is the £129m NFU Mutual Gilt & Corporate Bond fund, run by Kevin Watson since 1984.
This fund has produced alpha worth 2.11 per cent over the past five years against its benchmark, although it has only hovered around the second quartile in the sector over three and five years.
The fund has succeeded by being slow and steady, with volatility below the sector average.
Performance of fund vs sector over 5yrs
Source: FE Analytics
To that end it retains a higher weighting to UK government securities than most of its peers, with 45.44 per cent of the portfolio in gilts.
The fund is currently yielding 3.6 per cent.