Government bonds have found it difficult to make much ground over the year so far, as their yields sit at near to historic lows and the asset class is rattled by signs that the world’s central banks are moving to tighten monetary policy.
According to FE Analytics, the average fund in the IA UK Gilts sector has made a total return of just 0.27 per cent over 2017-to-date while the IA UK Index Linked Gilts peer group is not too far off with a 0.35 per cent gain.
Returns have been stronger in the other fixed income fund sectors. As the chart below shows, the average fund in the IA Sterling High Yield sector has made 6.14 per cent this year while the IA Sterling Strategic Bond sector is up 4.66 per cent.
Performance of bond sectors in 2017
Source: FE Analytics
Sentiment towards bonds remains low. The most recent Bank of America Merrill Lynch Global Fund Manager Survey, which looks at the positioning of 179 asset allocators running a collective $516bn, found that only 3 per cent of portfolio managers believe global bond yields will move lower in the next 12 months.
Some 82 per cent of the survey’s respondents think that bond yields will rise in the coming 12 months, meaning falls in bond prices, while a record 85 per cent of fund managers now consider bonds to be overvalued.
This dip in sentiment does not mean that all funds investing in the asset class have endured a tough year, however. FE Analytics shows that the best performing member of the six main fixed income sectors – IA Global Bonds, IA Sterling Corporate Bond, IA Sterling High Yield, IA Sterling Strategic Bond, IA UK Gilts and IA UK Index Linked Gilts – has generated a return of close to 20 per cent.
As can be seen in the following table, 16 funds from these six sectors have made returns in excess of 10 per cent since the start of the year. Admittedly, this is out of a total of 398 funds – meaning a rate of just over 4 per cent being in double-digit territory.
While IA Sterling High Yield was the bond sector with the highest year-to-date return, none of the top five funds on the below list come from this peer group and most reside in the IA Sterling Strategic Bond sector, where members have significant flexibility over where they can invest.
Source: FE Analytics
Topping the table is GAM Star Credit Opportunities EUR, which is an IA Global Bond fund run by FE Alpha Manager Anthony Smouha and Gregoire Mivelaz. The fund, as well as the GBP version of the product (which is in the IA Sterling Strategic Bond sector), has a specialist approach that focuses on the junior and subordinated debt of investment grade companies.
The belief behind the process is that there is a very low likelihood that quality financial companies will default on their debt, therefore the portfolio can pick up extra carry by holding lower tier debt issued by these businesses.
GAM Star Credit Opportunities EUR has established a strong track record on the back of this process: not only is it the best performing bond fund over 2017 but is one of the IA Global Bond sector’s top three performers over one-, three- and five-year time frames.
In their latest update, Smouha and Mivelaz argued that the portfolio could hold up if bond yields do start to tick up. “We continue to monitor the possibility of rising generic yields,” they said. “However, we also expect that the income offered by our portfolio with its blend of fixed-rate, fixed-to-floating bonds and discounted floating-rate notes will provide an attractive return as well as the potential for capital gains.”
The other four bond funds that are making 2017’s highest returns – Tideway GBP Hybrid Capital, Royal London Sterling Extra Yield Bond, GAM Star Credit Opportunities GBP and Legg Mason Western Asset Macro Opportunities Bond – all come from the IA Sterling Strategic Bond sector.
As its name suggests, Peter Doherty’s Tideway GBP Hybrid Capital fund focuses on hybrid bonds, or those that rank below ordinary senior debt but above common equity in the capital scale. Such assets combine both debt and equity characteristics, with Tideway arguing the fund is a “more secure alternative to equity income” as hybrid assets and expected cash flow are typically ranked senior to equity in the issuing company balance sheet.
The fund is the best performing member of the IA Sterling Strategic Bond sector over 2017-to-date and is the second highest returner since launch in September 2016 after making a 13.83 per cent total return.
Performance of funds over 2017
Source: FE Analytics
Royal London Sterling Extra Yield Bond is also having a strong 2017, reflecting the fact that high yield bonds have led fixed income returns over the year. Manager Eric Holt has run the portfolio since launch in April 2003, over which time it has made a top-decile 212.06 per cent total return; it’s also in the sector’s top decile over one, three and five years.
The fund’s focus on high yield bonds means that it has the potential to generate strong returns but this approach is riskier than the average IA Sterling Strategic Bond fund, with FE Analytics showing it as having the sector’s second highest annualised volatility and maximum drawdown numbers.
Legg Mason Western Asset Macro Opportunities Bond is managed on a team basis, headed up by Western Asset’s chief investment officer Kenneth Leach. The fund’s high conviction portfolio is built around the best ideas of the team and, unlike the other funds mentioned so far, does not focus on a specialist area – instead it can take long or short positions across a wide range of markets.
The fund is another with a strong track record outside of 2017, posting top-decile returns over one and three years. Since launch in the UK in February 2014 it has made a 28.57 per cent return, ranking it fourth in the IA Sterling Strategic Bond sector over this time.