Diversify with less risk via Royal London Ethical Bond

But having a portfolio totally invested in equities is not an option for many investors who need assets that will mitigate downside. And different segments of the bond market vary significantly, so not all will be affected in the same way.

So if your asset allocation requires you to hold bonds, you should look to a fund run by a manager who is experienced in navigating this complex environment. One such investor is Eric Holt, who runs Royal London Ethical Bond (GB00B7MT2J68).

This is a strategic bond fund, which means it does not have to focus on one type of bond. Its manager can change the allocation according to where he thinks the best opportunities are, and steer away from problem areas. The fund is mainly exposed to company debt rather than safer government bonds as Mr Holt looks to generate growth, but with an appreciation of safety.

And this approach seems to have paid off – the fund has outperformed the Investment Association (IA) Sterling Strategic Bond sector and the Markit iBoxx Sterling Non-Gilts index over one, three and five years.

Mr Holt makes sure Royal London Ethical Bond is not as correlated to the performance of equity markets as some high-yield and high-growth strategic bond funds. For example, over three years to 12 March, the fund had correlation coefficients of 0.48 and 0.51 to the MSCI World and FTSE 100 indices respectively, demonstrating a low correlation. A correlation coefficient of 1 means returns rise and fall perfectly in sync. By contrast, the IA Sterling Strategic Bond sector average correlations to these indices are 0.66 and 0.65 respectively.

Mr Holt has picked a wide range of companies, so when Royal London Ethical Bond's benchmark is rising it captures around 80 per cent of the rise, but when the market turns downwards its losses are 40 per cent lower. The fund also yields a respectable 3.84 per cent.

The fund has 3.4 per cent of its assets in AAA-rated bonds, which are considered to be less likely to default. AA and A bonds account for 31 per cent, and BBB-rated bonds account for 38 per cent of assets. And the fund has 9.5 per cent of its assets in high-yield bonds – those rated BB or lower – which are considered more likely to default.

The fund has an ethical overlay, so doesn't put its money into bonds issued by companies that operate in areas including alcohol, armaments, gambling, tobacco and pornography. 

Although Royal London Ethical Bond is conservative compared with some strategic bond funds, it holds some higher-risk debt so is by no means a capital preservation fund. It also has an average duration of 7.6 years – a measure of a portfolio's sensitivity to rising interest rates – which is higher than the IA Sterling Strategic Bond sector average. This means that if interest rates rise faster than investors expect and sentiment turns sharply against bond markets, this fund's returns could be adversely affected.

And while strategic bond funds can benefit from being able to invest in a wide variety of assets, this relies on their managers picking the right ones. It also means a strategic bond fund's risk profile can change very quickly, so you could end up holding something fairly different to what you originally invested in.  

However, this fund's performance proves Mr Holt's ability to be in the right investments at the right time – and without loading up on too much risk. So if you are looking for a portfolio diversifier Royal London Ethical Bond looks like a good way to access strong performance and an attractive yield with less risk than some of its peers. Buy. TL

Royal London Ethical Bond (GB00B7MT2J68)

Source: Morningstar,  *Royal London Asset Management as of 31.01.2018

Performance

Source: Royal London Asset Management as at 31.01.2018

Top 10 Holdings as at  31.01.18 (%)

Source: Royal London Asset Management

Sector breakdown as at  31.01.18  (%)

Source: Royal London Asset Management