Top 100 Funds: Bonds (11 Funds)

However, rising rates pose a threat to bond values, so you need to be selective about the types of fund you invest in. For this reason we continue to include many strategic bond funds in our selection. Their managers can invest across the fixed-income spectrum in an unconstrained way, focusing on the areas that look best and avoiding less desirable ones. However, strategic bond funds can be higher risk than traditional corporate bond funds, so are not necessarily suitable for lower-risk investors.

Funds dropped: Aberdeen Emerging Markets Bond (GB00B5V8SG93)

Four members of the panel suggested dropping this fund, which has underperformed its sector average over one, three and five years and is in either the third or fourth quartile in terms of performance. It offers an attractive yield of over 6 per cent, but even with income-focused investments it is important to get good total returns as well. There are other potentially better options for exposure to this area.

NEW ENTRANT: M&G Emerging Markets Bond (GB00B4TL2D89)

Three of the panel suggested adding M&G Emerging Markets Bond, which is among the top performing funds in the Investment Association (IA) Global Emerging Markets Bond sector in terms of performance over one, three and five years. The fund aims for income and capital growth by investing at least 70 per cent of its assets in bonds issued by governments and companies in emerging markets. It can also invest in emerging market currencies. Exposure to these assets is gained through direct holdings and derivatives.

“With a yield of close to 6 per cent, this fund provides a useful yield kicker and diversifier within higher-risk, income-focused portfolios,” says Gavin Haynes, managing director at Whitechurch Securities. “It has been managed by the highly experienced Claudia Calich since 2013 and she is supported by a well-resourced fixed-interest team at M&G. Their strategic flexible approach of holding both hard and local currencies, and sovereign and corporate bonds, is sensible given that most investors only have a small exposure to emerging market bonds.”

At the end of June, the fund’s allocation to local-currency government debt was 29.8 per cent and its weighting in hard-currency sovereigns was 40.7 per cent. And it had 23.7 per cent of its assets in hard-currency corporate credit and 5.3 per cent in local-currency corporate bonds. The fund has a reasonable ongoing charge of 0.78 per cent.

NEW ENTRANT: Schroder High Yield Opportunities (GB00B5143284)

Interest rates are on the rise in the US, and the UK has also recently seen a slight rise. This is usually not good news for bonds because the interest they pay out becomes slightly less attractive relative to the rates you can get on cash. But one way to minimise this risk is to invest in bonds that have very high yields so should remain well ahead of cash, even if there are a few interest rate rises.

Schroder High Yield Opportunities Fund invests in this asset class and offers a very attractive yield of about 6.2 per cent. The fund has also made outstanding total returns and is the top performer in its sector over one, three and five years.

Its manager, Michael Scott, and Schroders’ 30-plus-strong credit team aim to avoid companies likely to default – as well as looking for good investments. They assess both issuers’ individual merits and the economic situation.

“This fund invests primarily in pan-European high-yield bonds,” comment analysts at FundCalibre. “The team identifies investment themes that drive the global fixed-income market and then looks for assets that can achieve consistent performance through their market cycle. The fund is well diversified and uses a disciplined, repeatable process that draws on a variety of sources to generate a monthly income for investors. Under Michael Scott’s tenure, volatility has been controlled to offer investors some protection during tough markets. The monthly payment aspect should also appeal to investors seeking a regular income stream.”

However, high-yield bonds are very high risk as they are issued by companies considered more likely to default – their higher yields are to compensate for this extra risk. And as they are more sensitive to economic growth, high-yield bonds often perform more like shares than investment-grade corporate bonds. So you should have a high risk appetite and investment time horizon of at least five years if you invest in this fund.

MI Twenty Four Dynamic Bond (GB00B57TXN82)

MI Twenty Four Dynamic Bond aims to provide an attractive level of income, along with the opportunity for capital growth, by investing in a broad range of fixed-income assets, including investment-grade, high-yield and government bonds, and asset-backed securities. It uses derivatives such as interest rate and credit derivatives to optimise or reduce exposures, with the aim of performing well in both rising and falling rate environments throughout the credit cycle. It can also use synthetic short positions for hedging, and to take advantage of any deterioration in the market or specific issuers.

Jupiter Strategic Bond (GB00B544HM32)

Jupiter Strategic Bond aims for a high income with the prospect of capital growth by investing in higher-yielding fixed-income assets, including high-yield bonds, investment-grade bonds, government bonds, preference shares and convertible bonds. The fund can also use derivatives for investment purposes.

“This is a highly flexible bond fund run by a talented manager,” says Rob Morgan, pensions and investments analyst at Charles Stanley. “Ariel Bezalel has a wide range of tools at his disposal as he seeks to achieve strong returns and it could appeal to investors who seek higher returns from bond markets, but are prepared to take on more risk in return.”

Royal London Sterling Extra Yield Bond (IE00BJBQC361)

Royal London Sterling Extra Yield Bond is one of the best performing funds in the IA Sterling Strategic Bond sector, but is also one of the racier options. At the half-year point it had about 37 per cent of its assets in each of high-yield and unrated bonds, which have the potential to offer high returns but are considered to be more likely to default. But because it is a strategic bond fund with the freedom to invest in different areas of the debt markets, it can allocate away from these areas if there are problems.

“The willingness to look for opportunities in areas such as unrated bonds where others are reluctant to tread leads to a distinctive portfolio and contributes to a large distribution yield,” says Rob Morgan at Charles Stanley. “This means the fund could be of interest to those wishing to diversify their allocation to fixed income. For those seeking to boost the income from their portfolio, and prepared to accept the associated greater risks, this is an interesting fund run by an experienced and talented manager – Eric Holt.”

It also has one of the lowest ongoing charges of all active funds at 0.4 per cent.

Royal London Ethical Bond (GB00B7MT2J68)

If you want to access the stockpicking skills of Eric Holt (manager of Royal London Sterling Extra Yield Bond) via a less racy approach it could be worth considering Royal London Ethical Bond. This is also a top-performing Sterling Strategic Bond fund with top quartile returns over one, three and five years, but it invests predominantly in investment-grade corporate bonds.

Although a good choice for all kinds of investors seeking a bond fund of this risk profile it could be of particular interest to ethical investors. The fund avoids bonds issued by companies involved with alcohol, armaments, gambling, tobacco, pornography and non-medical animal testing, as well as ones that have a high environmental or human rights impact. It also has a reasonable ongoing charge of 0.54 per cent.

Fidelity Strategic Bond (GB00B469J896)

Fidelity Strategic Bond is not one of the best performing or highest yielding funds in the Sterling Strategic Bond sector. But this is because it is a lower-risk fund that aims to be a core bond fund, delivering regular income, low volatility and some diversification to other asset classes, including equities, rather than being top in its sector. Its managers look to generate attractive risk-adjusted returns by combining multiple, diversified investment positions advised by in-house fundamental credit research and quantitative modelling.

The fund is focused on higher-quality areas of the bond market, which are considered to be less risky but do not pay such high coupons. The average credit rating of its investments was A- at the end of June and investment-grade debt accounted for over 70 per cent of its assets. But because it is a strategic bond fund it does not have to stick with these areas if there is a good reason to get out of them.

The fund is run by a highly experienced manager, Ian Spreadbury, who has worked in investment management for 40 years and has run the fund since launch.

MI TwentyFour Monument Bond (GB00B3XVTT21)

MI TwentyFour Monument Bond invests in asset-backed securities (ABSs) including residential mortgages, which account for over half of its assets by value, as well as commercial mortgages, automobile leases and loans to small to medium-sized enterprises. This makes it a good diversifier to more conventional fixed-income funds.

MI TwentyFour Monument Bond targets investment-grade bonds, which are considered less likely to default, from European and Australian issuers, and has over half of its assets in UK issues.

The fund aims for an attractive level of income relative to prevailing interest rates while maintaining a strong focus on capital preservation, and has made positive returns in four out of the past five calendar years. “This fund provides sensible exposure to the specialist floating rate market suited to a rising rate environment,” says Rob Morgan at Charles Stanley.

Rathbone Ethical Bond (GB00B7FQJT36)

Rathbone Ethical Bond has an outstanding performance record and is in the top quartile of the IA Sterling Corporate Bond sector in terms of performance over one, three, five and 10 years – beating many funds that don’t have ethical constraints. Its attractive yield of over 4 per cent also means it is currently one of the highest yielders in its sector.

The fund’s manager, Bryn Jones, mainly invests in investment-grade bonds, which are considered less likely to default, with the aim of providing a regular and above-average income. Cash flow and strong balance sheets are key when selecting bonds, and Mr Jones and his team also analyse character, capacity, collateral and covenants. After that, an ethical overlay is applied, which consists of a negative and positive screening.

The fund excludes bonds issued by organisations involved in areas including alcohol, armaments, animal testing, tobacco and high-carbon-impact activities. At the end of July 2018, 38 per cent of the fund’s holdings by value were issued by banks, and 33 per cent by insurance companies.

“This fund typifies stable management, with Bryn having been at the helm for over 10 years,” comment analysts at FundCalibre. “It has managed to outperform regardless of its ethical constraints, illustrating that income and ethics can be combined without sacrifice. It is a solid core investment-grade fund.”

Henderson Diversified Income Trust (HDIV)

Last year Henderson Diversified Income Trust’s board decided to rebase its dividend on the grounds that downward pressure on bond and loan yields meant the 1.25p a quarter it had been paying couldn’t be maintained without taking risky positions. But it still aims to pay out at least 1.1p a quarter and offers an attractive yield of over 5 per cent.

The trust scrapped its performance fee as of1 November 2017, and its cap on total fees fell from 1.2 per cent of net assets a year to 0.65 per cent. This brought down its ongoing charge plus performance fee to 1 per cent at the end of its last financial year – 30 April 2018 – from 1.58 per cent at the end of its previous financial year. And this could fall further by the end of its current financial year because it is not paying a performance fee for any period of it. This would make it one of the cheapest listed debt funds.

Henderson Diversified Income invests globally in fixed-income assets, including secured loans, government, high-yield, corporate and unrated bonds, plus asset-backed securities. It can also use derivatives. It is run by experienced managers John Patullo and Jenna Barnard, co-heads of strategic fixed income at Janus Henderson Investors.

Mr Patullo has been cautious because he thinks global growth has peaked and will be low going ahead. Although he doesn’t expect a marked increase in defaults, he is wary of sectors such as retail and telecoms, and thinks investors should be prepared for capital volatility.

“If his view is accurate, Henderson Diversified Income should prove less volatile than some of its peers in the event of a market downturn, partly as a result of the flexibility of its mandate,” comment analysts at Winterflood. “In the meantime, its yield of 5 per cent remains attractive, particularly given the investment team’s emphasis on quality companies that are well positioned to continue servicing their debt obligations.”

City Merchants High Yield Trust (CMHY)

City Merchants High Yield is one of the better performing listed debt funds over the long term and has an attractive yield of over 5 per cent. The trust aims for high income and capital growth, and is run by highly regarded and experienced bond managers Paul Read and Paul Causer, alongside Rhys Davies.

It invests in a wide range of debt, with around 45 per cent of its assets in non-financial high-yield corporate bonds, focused on seasoned issuers that its managers think are not likely to default. Twenty-one per cent of its assets are in bank debt, mainly from large European issuers, and 13 per cent are in subordinated bonds issued by insurance companies.

It also invests in non-financial corporate hybrid capital instruments – bonds with equity-like characteristics from issuers in various sectors including telecoms and utilities. The trust’s managers believe the subordination risk of these more junior debt instruments is attractive in the context of the relatively strong balance sheets of the issuing companies.