Yields on government bonds and high-quality corporate debt have tumbled, as investors look for defensive assets and demand for safe-haven investments continues to be high. UK investors, for example, put a net £8bn into bond funds over the first seven months of 2019 alone.
Attractive yield
Strong total returns
Ethical approach
Flexible approach
Less defensive
With equity markets facing several challenges, it makes sense to hold some defensive assets. But the collapse in bond yields, which move inversely to prices, means that many investors will struggle to generate much of an income from higher-quality bonds. So you could do well to consider funds that offer diversification from equities by investing in higher-quality debt and also offer a good yield.
One fund that has reliably produced a good yield and impressive total returns is Rathbone Ethical Bond (GB00B7FQJT36). The fund, run by Bryn Jones and Noelle Cazalis, had a historical yield of 3.8 per cent at the end of July. This level of income has held up despite strong returns: Rathbone Ethical Bond outperformed the Investment Association (IA) Sterling Corporate Bond fund sector over three, five and 10 years to the end of August. It is also ahead of the IA Sterling High Yield and Sterling Strategic Bond sector averages over the same periods.
The fund’s managers form a “strongly defined view” on the factors that could affect bond performance, considering economic and political trends, company analysis and thematic ideas. Once these themes have been developed, the team carries out credit analysis to find the best holdings. The managers focus on characteristics such as an issuing company’s cash flow and balance sheet strength.
When the fund’s managers have identified potential holdings, they run an ethical screening process. Companies operating in areas such as weapons, tobacco, animal testing and gambling are excluded. The issuing companies must also have at least one positive environmental, social or corporate governance characteristic if their bonds are to be held by the fund.
Rathbone Ethical Bond is not required to invest in line with its benchmark, iBoxx non-gilts index, meaning it can differ significantly from both the broader market and other corporate bond funds. And it tends to have significant exposure to bonds issued by financial companies: at the end of July, 35.33 per cent of its assets were in bonds issued by insurance companies, 34.32 per cent in bonds issued by banks and 4.14 per cent in bonds issued by other types of financial services companies. At the end of July its largest holdings included debt issued by Lloyds Banking Group (LLOY) and RSA Insurance Group (RSA).
The fund’s idiosyncratic positioning and focus on investment-grade debt could make it a good source of diversification within a portfolio. But investors looking for a bond fund likely to perform well when equities are falling may need to look elsewhere as the fund’s ethical parameters mean it excludes UK government bonds, one of the most reliable safe-haven assets, and it tends to carry greater risk than some other fixed-income funds. Analysts at ratings agency FundCalibre point out that this fund is “not a diversification from equities or somewhere to hide if things get nasty”. For example, the volatility of 2018 meant Rathbone Ethical Bond fell 3.08 per cent last year, while the IA Sterling Corporate Bond sector average was a fall of 2.22 per cent.
However, the fund has provided both a good income and impressive returns over the years, despite bouts of volatility. So if you are an ethical or conventional investor who wants a good yield when income is scarce, and has a long enough investment horizon to tolerate falls along the way, this fund is still a good option. Buy. DB
Rathbone Ethical Bond (GB00B7FQJT36)
| Price | 100.54p | Mean return | 5.32% |
| IA Sector | Sterling Corporate Bond | Sharpe ratio | 1.35 |
| Fund type | Unit trust | Standard deviation | 3.50% |
| Fund size | £1.3bn | Ongoing charge | 0.67% |
| No of holdings | 219 | Yield | 4.02% |
| Set-up date | 14-May-02 | More details | rutm.com |
| Manager start date | 01 November 2004 |
Source: Morningstar as at 9 September 2019
Performance
| Fund/benchmark | 1-year total return (%) | 3-year cumulative total return (%) | 5-year cumulative total return (%) | 10-year cumulative total return (%) |
| Rathbone Ethical Bond | 8.27 | 16.64 | 32.2 | 123.73 |
| Iboxx UK Sterling Non-Gilts All Maturities index | 9.04 | 8.46 | 30.36 | 89.76 |
| IA Sterling Corporate Bond sector average | 8.43 | 9.09 | 26.04 | 77.34 |
Source: FE Analytics as at 31 August 2019
Top 10 holdings
| Rothesay Life 8.0% 30/10/2025 | 1.89% |
| Royal London 6.125% 13/11/2028 | 1.85% |
| HSBC 5.844% Perp | 1.80% |
| Bank of Scotland 7.281% Perp | 1.79% |
| Rabobank Nederland 6.91% Perp | 1.75% |
| BPCE 5.25% 16/04/2029 | 1.73% |
| Axa 5.453% Perp | 1.72% |
| HBOS 7.881% Perp | 1.64% |
| Lloyds 13.0% Perp | 1.62% |
| RSA Insurance Group 5.125% 10/10/2025 | 1.62% |
Source: Rathbones as at 31 July 2019
Sector breakdown
| Insurance | 35.33% |
| Banks | 34.32% |
| Social housing | 8.50% |
| Financial services | 4.14% |
| Supranational | 3.71% |
| Infrastructure | 2.14% |
| Telecoms | 1.68% |
| Renewable energy | 1.46% |
| Commercial finance | 1.44% |
| Real estate | 1.13% |
| Tourism | 0.91% |
| Social finance | 0.81% |
| Mortgage-backed securities | 0.72% |
| Consumer services | 0.42% |
| Other | 0.47% |
| Cash | 2.82% |
Source: Rathbones as at 31 July 2019
