An appreciation of a strategic bond fund’s likely composition and asset allocation is particularly pertinent when judging its success or outcome, according to The Adviser Centre’s Gill Hutchison.
With strategic bond funds coming in all shapes and sizes, The Adviser Centre’s research director said the IA Sterling Strategic Bond sector can be one of the more difficult areas of the market to navigate.
As such, understanding whether strategic bond funds characteristics are well-suited to the objectives and type of outcomes investors are seeking is key, especially for those following a granular asset allocation approach, Hutchison noted.
“Investors should be careful when using strategic bond funds for ‘corporate bond’ exposure, as this usually implies an investment grade allocation,” she said.
“Some strategic bond funds are more closely correlated with high yield bond markets than they are with investment grade markets.”
To compare funds with similar attributes, The Adviser Centre has grouped the funds in the IA Sterling Strategic Bond sector into several categories – although it must be noted that even within categories nuances in approaches may result in a variety of outcomes according to market conditions.
Dynamic
Those funds categorised as ‘dynamic’ by The Adviser Centre are the most flexible ones, where managers aim to finesse fixed income exposure according to changing interest rates and credit cycles, with use of this flexibility varying considerable depending on the manager.
The managers of these funds are characterised by their high conviction approach and their willingness to take elevated risks, the firm noted.
They can also use different instruments -from traditional bond securities to a range of derivatives- to assist them in expressing views and isolating risks.
“Those funds with more variable performance tendencies might be used more comfortably as part of a blend of funds to provide a differentiated outcome,” noted Hutchison.
“Man GLG Strategic Bond is one of the most active and flexible,” she said. “In many ways, its approach recalls the early concepts of what a strategic bond fund could represent – the ultimate expression of a manager’s best ideas, implemented with complete flexibility, according to the opportunity set presented by fixed income markets.”
Performance of fund vs sector since launch
Source: FE Analytics
Since launch at the end of 2011, the fund has delivered a return of 38.50 per cent compared with a 37.79 per cent gain for the sector peer, as shown below.
However, Hutchison noted that there are some major hurdles to overcome when attempting to execute such an approach.
“Firstly, the fund’s investors must accept the potential for a bumpy risk/return ride,” she explained “Secondly, market liquidity may not be in the manager’s favour. These challenges magnify as fund sizes increase.
“Lastly, costs of trading fixed instruments can restrict the opportunity set, particularly on a short-term view.”
According to Hutchison, as managers have navigated different fixed income environments, strategic bond funds have tended to move away from the “performing well in all environments” promise to more formalised structures.
These have been framed around asset allocation/risk limits or outcome-based objectives, with Man GLG Strategic Bond one of the few in the very small cohort of funds that remain true to the original strategic bond concept.
“It is a difficult undertaking, but sophisticated trading systems and the ability to access a wide range of securities and derivatives renders it more achievable,” Hutchison said.
Current funds in this category featuring on The Adviser Centre’s recommended list are Aberdeen Strategic Bond and Janus Henderson Strategic Bond. Kames Strategic Bond features on their ‘positive watch’ and M&G Optimal Income is one on their ‘established list’.
Diversified
The Adviser Centre categorises as ‘diversified’ strategic bond funds as those managed with reference to a structured and diversified asset allocation framework.
They tend to have permanent exposure to the various fixed income segments of government bonds, corporate bonds and high yield bonds with tactical views being expressed by flexing these allocations.
Thus, given their clear structures and permanent diversification across bond markets, Hutchison noted these are appropriate for use as “one-stop-shops” for broad fixed income exposure.
Performance of fund vs sector over 3yrs
Source: FE Analytics
An example of diversified fund The Adviser Centre currently has on their recommended list is the £1.7bn Fidelity Strategic Bond, overseen by FE Alpha Manager Ian Spreadbury alongside deputy managers Claudio Ferrarese and Timothy Foster.
Value
‘Value’ strategic bond funds are also flexible, but it this case, the managers would base their positioning around long-term assessment of value in bond markets.
In order to moderate positioning or take advantage of short term opportunities, tactical trading can be employed.
Value strategic bond funds can also shift their positioning from ultra-defensive to higher risk depending on the available opportunity set.
Invesco Perpetual Tactical Bond, overseen by Paul Causer alongside Paul Read is an example of value strategic bond fund The Adviser Centre currently includes on their list of recommended funds.
Structural high yield exposure
Hutchiston said funds in the ‘structural high yield exposure’ category have higher correlation to the movements of credit markets and often underperform other funds in the sector when higher risk credit is under pressure.
That said, the risk attributes of higher-risk exposure can be finessed according to the credit backdrop and the remaining parts of the portfolio can also be used to diversify and moderate risk and opportunity, she explained.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The firm recommends one fund that falls into this category: the £1.3bn, five FE Crown-rated Artemis Strategic Bond fund, overseen by Alex Ralph and James Foster.
“The fund has specific characteristics that mark it out from ‘dynamic funds’ but also shares some common ground with them,” Hutchison noted.
Income objectives
This category includes the funds in the sector that have the specific objective of achieving high income from bonds. It can also include funds that invest up to 20 per cent in equities.
Examples of these funds included in The Adviser Centre’s recommended funds list are Artemis High Income, Invesco Perpetual Monthly Income Plus, PIMCO Select UK Income Bond and Royal London Sterling Extra Yield Bond.