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Get safe bond exposure with Kames

If you are worried by the Financial Conduct Authority's warning on corporate bond funds, this fund could be the answer.
August 6, 2014

Bonds have traditionally been viewed by investors as a "safer" asset class to equities. But with the imminent threat of interest rates rising, the Financial Conduct Authority (FCA) has issued a warning to consumers about the risks of investing in corporate bond funds.

IC TIP: Buy
Tip style
Growth
Risk rating
Low
Timescale
Long Term
Bull points
  • Strong risk controls
  • Experienced managers
  • Flexible investment strategy
  • Consistent track record
Bear points
  • Average performance

The watchdog is concerned about liquidity in the bond market, warning that in extreme market conditions, fund managers could find themselves unable to sell sufficient quantities of bond holdings to fulfil redemption orders, leaving investors unable to sell their bond fund holdings. All this could potentially depress bond prices, and cause widespread disappointment among investors.

Professional investors say the funds that are likely to be worst affected are those that contain high yield, short duration bonds. This is because once they are bought, the existing bonds can be replaced with shorter coupons. But these opportunities seem to be rapidly drying up. Some of the bond funds paying the best yields are looking increasingly unsustainable. For example, the AXA US short duration high yield bond fund (ISIN: GB00B59VLT43) had a 7 per cent yield in 2010, but it is already down to 2.5 per cent a year, leading investors to question whether the risk of investing is still worth the reward.

If you're looking for a safer bet, you'd probably be better off with an absolute return bond fund, according to Andrew Birt, financial planner and bond fund expert at Saunderson House. They are considered less risky because they are faster moving, and can use derivatives to enhance their control mechanisms.

One fund to consider is the Kames Absolute Return Bond fund (ISIN: IE00B6SPX874), which aims to generate positive absolute returns for investors over a rolling three-year period, irrespective of market conditions. It's a fast growing fund, which has grown from £360m at the end of June to £407m on 4 August 2014, according to Morningstar.

It invests in debt in all corners of the globe, and in any currency, although the vast majority of its currency exposures are in hedged sterling (93.37 per cent), with 2 per cent in the euro and 1 per cent in US dollars. It invests in everything from AAA government bonds through to high yield and emerging market bonds. It can invest in all types of fixed and floating rate fixed income securities, and it also uses financial derivatives to run a long/short strategy.

Making it particularly safe, according to Mr Birt, are its risk controls. The money in the fund is placed in three separate "buckets", some of which have tighter risk controls than others. Around half the money is in a bucket which can only be invested in investment grade corporate bonds with maturity dates of more than two years. The rest of the money is used to form a strategy which aims for market neutrality by adopting simultaneous long and short strategies. And according to co-manager Colin Finlayson, the strategy means it is not correlated to the rest of the bond market.

In charge of the fund are Stephen Snowden and Mr Finlayson - both experienced bond fund managers. They have outperformed their peer group (FO Absolute Return) over 10 and seven years, respectively, according to Trustnet data on 4 August 2014.

Its top holdings are UK Treasury 3.25 per cent 22/01/2044 per cent bonds (2.86 per cent of the portfolio), Canadian 3.5 per cent 01/12/2045 bonds (2.62 per cent of the portfolio) and UK (GOVT) 3.5 per cent 22/07/2068 bonds (2.20 per cent of the portfolio).

Since the fund launched on 30 September 2011, it has returned 6.52 per cent, according to its latest factsheet (to 30 June 2014). And over one year (to 04 August 2014), it has produced 2 per cent, compared to its benchmark index, the BBA Libor three-month GBP, which returned 0.5 per cent, according to Morningstar. The fund also has reasonable charges of 0.76 per cent a year. This fund is unlikely to shoot the lights out in terms of performance, but if you're looking for a safe cash replacement for your portfolio, it is worth considering. Buy.

Performance data for Kames Absolute Return Bond fund

FUND TYPE Unit Trust1-YEAR PERFORMANCE2.0%
FUND SIZE£407m1-YEAR BENCHMARK PERFORMANCE0.5%
No OF HOLDINGS105TOTAL EXPENSE RATIO0.7%
SET UP DATE30 Sep 2011YIELD0.0%
MANAGER START DATE30 Sep 2011MINIMUM INVESTMENT£500
PRICE10.673 GBPMORE DETAILSwww.kamescapital.com
IMA SECTORTargeted Absolute ReturnSourceMorningstar
Performance data as on 04 August 2014

Sector breakdownAllocation (%)
BANKS 27.5
CASH 8.5
COLLATERALISED  6.7
GOVERNMENT7.6
INDUSTRIALS 24.5
OTHER FINANCIALS  11.4
SUB-SOVEREIGN  1.2
TMT 7.4
UTILITIES5.0
Source: Kames on 30 June 2014

Top 10 holdingsAllocation (%)
UK TREASURY 3.25% 22/01/2044 2.8
CANADIAN GOV 3.5% 01/12/2045  2.6
UK (GOVT) 3.5% 22/07/2068  2.2
COMPASS GRP PLC 7% 08/12/2014  2.1
BAE SYST PLC 10.75% 24/11/2014 2.0
ENW CAPITAL FIN PL 6.75% 20/06/2015 1.9
VODAFONE GRP PLC 4.625% 08/09/2014 1.9
VOLKSWAGEN FIN FRN 12/10/2015 1.8
DEUTSCHE BNK AG FRN 15/12/2015  1.7
GREENE KING FIN FRN 15/09/2021 1.7
Source: Kames on 30 June 2014