Some commentators have recommended jettisoning them altogether, while many others have upped their weighting to alternatives, either to complement or replace their conventional fixed interest exposure.
Alternatives could include anything from cash, property or absolute return funds.
One of the less radical alternatives is to stick with IMA Sterling Strategic Bond funds with flexible remits, which allow them to implement a number of strategies designed to limit sensitivity to rates.
A number of commentators have warned that shifting out of conventional bonds entirely would be making hasty assumptions about the future direction of the bond market.
There is still value in holding these assets, say analysts such as FE’s head of research Rob Gleeson, who argues that there is still the very real possibility of deterioration in the world economy in the medium-term, which would lead to bond yields remaining at low levels.
The direction of interest rates and therefore bond prices has been hard to call this year, with the market changing direction on a number of occasions.
Performance of indices over 1yr
Source: FE Analytics
One fund that is seeking to mitigate the risks of rising interest rates is Cazenove Strategic Bond, recommended by Rob Morgan of Charles Stanley Direct.
The fund has marginally outperformed the IMA Sterling Strategic Bond sector over the last 12 months, making 4.77 per cent.
This is thanks to its defensive nature coming into its own in the past month, as prices spiked and yields fell.
The fund’s volatility over the past year is just 2.38 per cent, well behind the 3.05 per cent of its peers.
Performance of fund vs sector and index over 1yr
Source: FE Analytics
Morgan (pictured) explains that the manager, Peter Harvey, uses a number of sophisticated strategies to produce such a low-risk profile.
"Most straightforwardly, Harvey purchases 'floating rate' bonds, where the income paid rises if interest rates go up," Morgan said. "He also permanently 'shorts' UK government bonds [gilts], which has the effect of stripping out some of the interest rate sensitivity of the fund, but leaving the risk associated with lending to the underlying businesses within the portfolio."
The analyst explains that Harvey generates his returns from corporate bonds, many in quite risky sectors.
"Like most bond funds, there is a wide spread of businesses represented in the underlying portfolio, including Virgin Media, Daily Mail, Jaguar Land Rover and Equiniti," he said.
"There is also quite a bit of exposure to the banking sector. Harvey believes increased regulation is making banks a more secure prospect for holders of their 'senior' debt and some attractive yields remain available. For example, represented in the fund's top-10 holdings are bonds from HSBC and Nationwide."
"The fund is not immune to interest rate rises, but it should, in theory, be less sensitive than the majority of bond funds. However, the dampening of volatility comes at a price, namely a lower yield than many at around 5.3 per cent (variable, not guaranteed) for the clean-priced X-class units."
Data from FE Analytics shows that the fund’s yield is significantly higher than the average IMA Sterling Strategic Bond fund, which pays out 4.27 per cent.
"This seems healthy but nearly half the fund is invested in higher risk, higher yield bonds, which carry a higher chance of default," Morgan warns. "In short, the fund predominantly takes credit risk rather than interest rate risk."
Bestinvest’s Jason Hollands points out that the fund takes its annual management charge (AMC) from capital, a practice he prefers to avoid.
He prefers the Kames Strategic Bond fund, which has an annualised volatility of just 2.86 per cent over the last year, according to FE Analytics. It takes the AMC from income.
The yield of 2.4 per cent is less generous, however.
"Kames Strategic Bond also has a more conservative approach of capping high yield exposure to no more than 30 per cent," he said.
Our data shows it has performed roughly in line with the sector average over 12 months, making 4.46 per cent, albeit with lower volatility.
Performance of funds vs sector over 1yr
Source: FE Analytics
Fidelity Strategic Bond has been even less volatile in recent years, Hollands notes, though again with a lower running yield at 2.2 per cent.
"For me, a great all-rounder is Legal & General Dynamic Bond," he said. "The volatility has been higher at 5.7 per cent [over three years], but the yield is 4.9 per cent and the fund has delivered good performance through the credit crisis and beyond."
"The fund uses derivatives as well as cash positions to express the manager’s views and manage both credit and interest rate risk. Charges are split between income and capital."
