Improving economic data led by a wholesale recovery in the US has led many experts to predict global interest rates will be hiked as early as next year, which is bad news for many quarters of the fixed interest market.
When investors can get more bang for their buck in a regular savings account, the relative attractiveness of many bond securities automatically diminishes, thus pushing yields higher and prices lower.
Longer-duration bonds, which are more susceptible to a rise in interest rates, look particularly vulnerable and have already seen a big sell-off this year in light of rumours that rates could be increased earlier than expected. In May and June, US long-dated Tips fell around 25 per cent, for example.
For those investors who want to retain their fixed interest exposure, one way to protect against this very real threat is to hold a short-duration bond fund, which is less exposed to interest rate movements.
Short-duration bonds either have a shorter maturity or pay out a greater proportion of their total return prior to the end-date, meaning that the likelihood of them being affected by a hike is significantly lower.
There are a limited number of specific short-duration bond funds available to investors, but the growing demand for them has led to a number of high-profile launches in recent months.
Just today, Royal London announced the launch of three vehicles: Royal London Short Duration Gilt, Royal London Short Duration Credit and Royal London Short Duration Global Index Linked, which have received regulatory approval and will be available from 7 October this year.
These funds join Royal London Duration Hedged Credit and Royal London Short Duration Global High Yield, which were launched in September 2012 and February 2013, respectively.
The Royal London Short Duration Gilt fund will be managed by Craig Inches, who already runs the Royal London UK Government Bond portfolio. Duration will be actively managed to exploit movements in short-dated yields, while the fund will also have the flexibility to invest tactically in assets such as index-linked government bonds, corporate bonds, or non-UK government bonds.
The Royal London Short Duration Global Index Linked fund will be managed by George Henderson. The fund will target the shorter end of the maturity spectrum, aiming to deliver inflation-linked returns with limited interest rate risk. Henderson already runs the Royal London Global Index Linked portfolio.
Finally, the Royal London Short Duration Credit fund will be managed by Paola Binns, who currently runs Royal London Duration Hedged Credit. This new fund will target shorter-dated bonds of up to 10 years maturity – an area of the sterling investment grade credit market that Royal London believes offers particularly good value.
Inches, Henderson and Binns are all ahead of their peer group composite over a three-year period. Inches is the only one of these with both a five- and 10-year track record – he is ahead of his peers over both time frames.
Performance of managers vs peers
| Name | 3yr (%) | 5yr (%) | 10yr (%) |
|---|---|---|---|
| Paola Binns | 23.82 | 54.21 | N/A |
| Paola Binns peer group composite | 17.06 | 42.61 | N/A |
| Craig Inches | 11.39 | 39.1 | 64.66 |
| Craig Inches peer group composite | 10.85 | 27.15 | 51.65 |
| George Henderson | 10.83 | N/A | N/A |
| George Henderson peer group composite | 7.62 | N/A | N/A |
Source: FE Analytics
Commenting on the launches, Jonathan Platt, head of fixed income at Royal London, said: "The last year has seen improving economic data, potential unwinding of central bank stimulus measures, and guidance on the path of interest rates."
"Government bond yields in the UK have risen from the historic low levels reached in 2012. Irrespective of the extent and pace of further increases in yields, returns from bonds are likely to be volatile."
"The natural response of investors to an environment of rising and/or volatile yields is to reduce bond portfolio risk by lowering the overall duration of their portfolio."
"These funds will enhance investors' ability to do this, while allowing the portfolio managers to focus on enhancing returns through active stock selection, duration management and allocation to other asset classes on a strategic and tactical basis."
For investors looking for a fund with a more established track record, there are a few options available. One of the largest and most established is the £379m M&G Short-Dated Corporate Bond fund, which is headed up by Ben Lord.
The fund, which was launched in 1993, attempts to deliver a steady flow of income but places an emphasis on downside protection. Bar a rocky period during the financial crisis, M&G Short-Dated Corporate Bond has been very steady over the last decade, returning 28.17 per cent. This is significantly below its IMA Corporate Bond sector average, though M&G is keen to point out that the fund does not aim to beat any specific index.
Performance of fund and sector over 10yrs
Source: FE Analytics
The fund has a modest yield at 1.37 per cent and has ongoing charges of 0.65 per cent.
Its two biggest rivals in the Corporate Bond sector are Threadneedle Short Dated Corporate Bond and AXA Sterling Credit Short Duration Bond. Both were launched in 2010 and have so far managed to beat cash and inflation, with very low volatility. They have a higher yield than the M&G fund, at 2 and 2.9 per cent, respectively.
Performance of funds vs sector since Nov 2010
Source: FE Analytics
Outside of the UK, the AXA US Short Duration High Yield Bond fund is a standout choice. With a yield of 5 per cent it is one of the highest yielding portfolios in the IMA Global Bonds sector, and is also a top-quartile performer on a total return basis over a three-year period and since its launch in 2010.
Manager Carl Whitbeck invests predominantly in sub-investment grade debt, which results in his performance being significantly more volatile than the choices mentioned previously. However, the fund has still offered investors a much smoother journey than its IMA Global Bonds sector.
Performance of funds and sector over 3yrs
Source: FE Analytics
Other options in the IMA Global Bonds sector include the $4.6bn Pimco GIS Low Average Duration and $2.1bn Dimensional Global Short Dated Bond funds, which are both investment-trade focused.
Neil Shillito (pictured), director of SG Management, says he can see the merits of holding a short-duration fund for anyone who is actively managing their portfolio on a regular basis, but in the main believes that a strategic bond fund gives investors enough flexibility. "I do think strategic bond funds have enough freedom to react to interest rate risk," he said. "A short-dated fund has its obvious benefits if you have a particular view on rates, but they are for a very specific purpose, and sometimes for a very short-term view."
"I think they have a place for family offices or ultra-high net-worth individuals who want to put a couple of million into something for the short-term."
"The people we run money for tend to be higher net-worth, but we’re still talking about relatively small amounts of money and their outlook tends to be longer. For that reason, I think a strategic bond manager is a more realistic option."
Funds operating in the IMA Sterling Strategic Bond sector must have at least 80 per cent of their assets in sterling-denominated or sterling-hedged assets, but apart from that have the flexibility to invest across the government and corporate debt markets, and are unconstrained when it comes to duration.
Shillito points out that the vast majority of bond managers protected effectively against the downside during the sell-off in long-duration debt earlier in the year. According to FE data, of the 181 funds across the IMA Strategic Corporate Bond, IMA Corporate Bond and IMA High Yield sectors, 127 – or 70 per cent – have made money this year. Only 12 funds have lost more than 2 per cent.
This, Shillito says, shows that investors do not have to be in a specialised bond fund to avoid interest rate risk.
