Investors flocked to fixed-income funds in June amid improving conditions for the bond market, but a heavy preference for more flexible funds suggests they are taking a cautious approach to this asset class for the time being. Sales data from the Investment Association (IA), the trade body which represents UK asset managers, showed that bonds were the most popular asset class for the fourth consecutive month in June, taking net inflows of £2.4bn.
The IA Sterling Corporate Bond fund sector made net retail sales of £453m, Global Bonds made £359m and UK Gilts made £108m. But it was flexible bond funds that attracted the most money, with the Sterling Strategic Bond sector making net retail sales of £1.1bn in June. This is the highest amount taken by any sector since November 2017 when Sterling Strategic Bond funds again topped the charts.
Appetite for this type of fund can be substantial. Sterling Strategic Bond is the only IA fund sector to have ever taken in more than £1bn in a single month, and it has now done so on four separate occasions. And Sterling Strategic Bond was the best-selling IA bond sector for a fourth consecutive month in June.
One possible reason for this may be that investors have been reassessing bond funds as monetary policy becomes more accommodative. The US central bank, the Federal Reserve, backed away from interest rate increases at the end of last year and cut rates for the first time in a decade at the end of July, while the Bank of England looks unlikely to raise them soon. Bonds tend to perform poorly when interest rates rise, in part because higher rates make their yields look less attractive to investors.
The fact that investors are favouring strategic bond funds suggests many remain cautious about fixed income – despite low interest rates. This is because strategic bond funds can invest in various areas of the bond markets and in some cases other types of debt instruments, so if interest rates rise they can allocate to assets that could still offer an attractive income. Bond funds in other sectors typically can only invest in one type of bond meaning they cannot do this, and have less scope for mitigating the effect of interest rate rises.
However, some of the most popular Sterling Strategic Bond funds have recently taken a more defensive approach by backing higher-quality bonds that typically pay out a lower income. Jupiter Strategic Bond (GB00BN8T5596), one of the biggest funds in the sector, had 42.5 per cent of its assets allocated to government bonds at the end of June. The fund’s manager, Ariel Bezalel, looked to de-risk it at the start of 2018 by upping exposure to high-quality government bonds and reducing allocations to riskier high-yield corporate debt. He believes that the US economy is getting closer to its next recession, and warned at the end of June that the Federal Reserve had “very little ammunition to stimulate the economy, given it remains constrained by its huge balance sheet and rates that are still close to historic lows”.
M&G Optimal Income (GB00B1H05601), another large strategic bond fund, also looked defensively positioned at the end of June, with a 21.8 per cent net allocation to government bonds and 47.8 per cent in investment grade corporate bonds. These are less likely to default than riskier bonds but typically do not pay such a high income.
However, some strategic bond funds have greater exposure to assets traditionally deemed to be riskier, but which offer higher yields. Artemis High Income (GB00B2PLJN71), which is managed by Alex Ralph, had 52.8 per cent of its assets in non-investment grade corporate bonds at the end of June.
Bond investors currently face several challenges, even with central bank policy looking more accommodative – another possible reason why strategic bond funds are in favour. Concerns about the asset class include companies with lower credit ratings taking on too much debt and government bonds, which have performed strongly this year, looking too expensive. And yields, which move inversely to prices, have reached extremely low levels with some government bonds in Europe now offering negative yields. This means their prices are so high that new buyers accept a loss to hold the bonds.
