Top 100 Funds 2019: Bonds

NEW ENTRANT: AXA Sterling Credit Short Duration Bond (GB00B5VL0B78)

Mr Liddell suggested adding AXA Sterling Credit Short Duration Bond because it makes consistent returns and has a lower risk profile. The fund’s investment team invests in securities with maturities or call dates of less than five years to minimise volatility and interest rate risk, and the fund makes positive returns in most years. They aim for incremental investment returns with a focus on income generation and capital preservation. They also look to reduce risk by diversifying the fund across various sectors, issuers, ratings and maturities. It had 195 holdings at the end of July.

The fund has nearly all of its assets in investment-grade bonds, which are considered less likely to default.

“AXA Sterling Credit Short Duration Bond fund benefits from a strong team, a simple strategy and great resources,” say analysts at FundCalibre. “By targeting an often overlooked part of the bond market, manager Nicolas Trindade is able to exploit ongoing mis-priced opportunities to generate lower-risk income for investors. The fund should perform better than its peers when interest rates rise. Mr Trindade has managed the fund since launch in 2010, and is supported by a large team of global analysts, macroeconomic strategists and risk management specialists.”

The fund has a very low ongoing charge of 0.42 per cent.

NEW ENTRANT: Baillie Gifford High Yield Bond (GB0030816713)

Ms Schooling-Latter suggested adding Baillie Gifford High Yield Bond following a manager departure at Schroder High Yield Opportunities (see below). High-yield bonds are a riskier type of fixed-income security that are considered more likely to default, but have higher yields than less risky bonds and can make strong returns. You should therefore only invest in this fund if you have a high risk appetite.

Baillie Gifford High Yield Bond is among the 10 best performing funds in the IA Sterling High Yield sector over one, three and five years. It only has a 12-month yield of 3.83 per cent, but it makes better total returns than most of its peers, in line with its objective.

The fund’s managers, Robert Baltzer and Lucy Isles, aim for a relatively high total return by investing in bonds issued by companies they think will weather economic fluctuations due to their competitive position, financial structure or management. And they analyse attributes such as companies’ debt and valuation to assess risk.

The fund typically has 50 to 90 holdings and had 81 at the end of June. It is well diversified across a range of sectors.

“This fund offers investors access to a portfolio of predominantly UK, US and European high-yield bonds,” say analysts at FundCalibre. “As with all other Baillie Gifford funds, the managers focus on stockpicking, so the portfolio is likely to be concentrated and turnover low, as the managers back their ideas with conviction and give them time to come to fruition.”

The fund has one of the lowest ongoing charges of all active funds available to UK private investors, at 0.37 per cent.

NEW ENTRANT: M&G Global Macro Bond (GB00B78PH601)

Mr Liddell suggested adding M&G Global Macro Bond because of its strong performance and ability to have a good spread of risk. Similar to a strategic bond fund, it can invest in many types of fixed income giving it the ability to focus on better performing areas and, importantly, avoid ones that don’t look so good. But it has an added flexibility – it can invest in bonds denominated in currencies other than Sterling.

This increases the number of potential investments it can put its assets into so it has even more ability to target the best areas and avoid the poor ones. But this also adds a major risk because movements in exchange rates may adversely affect the value of your investment in it.

At the end of July, 31 per cent of its exposure was to the US dollar, 24.3 per cent to the Euro, 19.2 per cent to the Japanese yen and 18.6 per cent to Sterling. The fund could provide diversification to the fixed interest allocation of a portfolio, especially one focused on funds that invest in Sterling denominated bonds.

The fund's managers can also make extensive use of derivatives which have the potential to improve returns and mitigate downside, but can also magnify the size of losses if they make the wrong calls.

However, it has been run since launch in 1999 by a highly regarded and experienced manager, Jim Leaviss, head of retail fixed interest at M&G Investments. He has a good record of making the right investment decisions and the fund has beaten the IA Global Bonds sector average over one, three and five years. But its 12 month yield of 3.22 is lower than that of some of its sector peers.

The fund’s deputy manager, Claudia Calich, is an experienced emerging markets debt specialist who runs a number of funds including M&G Emerging Markets Bond (see below).

They are supported by a large and experienced team of credit analysts.

The fund's allocations and exposures can change so, for example, its exposure to riskier bonds could increase. And it can experience periods of volatility so you should only invest in it if you have a higher risk appetite and long-term investment horizon.

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 to optimise or reduce exposures, with the aim of performing well in both rising and falling rate environments throughout the credit cycle.

“If you take one of the most capable and highly regarded fixed-income teams in the country and give them what amounts to a ‘go-anywhere’ mandate this strikes me as a recipe for success – and it has certainly done well so far,” says Mr Seager-Scott. “The main factor to be aware of, though, is that this more aggressive fund tends to come with slightly elevated risk within the bond space.”

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, Ariel Bezalel,” says Mr Morgan. “He 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 has a strong historic performance record, but is also one of the racier options in the IA Sterling Strategic Bond sector. At the end of June, 38.5 per cent of its assets were in high-yield bonds and 34 per cent in 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 could 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, meaning the fund could be of interest to those wishing to diversify their allocation to fixed income,” says Mr Morgan. “For those seeking to boost the income from their portfolio and who are prepared to accept the associated greater risks of default and illiquidity, this is an interesting fund run by an experienced and talented manager.”

Its Y share has one of the lowest ongoing charges of all active funds, at 0.4 per cent.

Royal London Ethical Bond (GB00BJ4KSY83)

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 consistently beats the IA Sterling Strategic Bond sector average and is often in the top quartile of this sector in terms of performance, but invests predominantly in investment-grade corporate bonds, in which it had nearly three-quarters of its assets at the end of June 2019.

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. The M share class also has a reasonable ongoing charge of 0.55 per cent.

MI TwentyFour Monument Bond (GB00B3XVTT21)

MI TwentyFour Monument Bond aims for an attractive level of income relative to prevailing interest rates while maintaining a strong focus on capital preservation. This fund will not generate high returns, but should also not make great losses, so has a role as a lower volatility and less correlated holding in a portfolio.

The fund mainly invests in European asset-backed securities with an investment-grade rating, which means they are considered less likely to default. It invests in assets including residential mortgages, which accounted for 60 per cent of its assets at the end of July, as well as commercial mortgages, automobile loans, and loans to small to medium-sized enterprises. This makes it a good diversifier to more conventional fixed-income funds.

Rathbone Ethical Bond (GB00B7FQJT36)

Rathbone Ethical Bond has a very good performance record and is in the top quartile of the IA Sterling Corporate Bond sector in terms of performance over three, five and 10 years – beating many funds that don’t have ethical constraints. Its attractive yield of over 4 per cent also means [at time of writing] it is 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. It favours bonds issued by companies that have progressive or well-developed practices in areas including employment, human rights and management of environmental impacts.

M&G Emerging Markets Bond (GB00B4TL2D89)

M&G Emerging Markets Bond is among the top performing funds in the IA Global Emerging Markets Bond sector in terms of performance over one, three and five years, and has a very attractive yield of nearly 6 per cent. 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. It gets exposure to these assets through direct holdings and derivatives.

At the end of June, the fund had 26.9 per cent of its assets in local currency government debt, 43.1 per cent in hard-currency government debt and 24.8 per cent in hard-currency corporate credit.

“Claudia Calich, manager of M&G Emerging Markets Bond, is extremely knowledgeable about this very complex asset class and her track record speaks for itself,” say analysts at FundCalibre. “The [fund’s] strategy is very flexible, meaning she can find the best opportunities available on both an income and capital growth basis. And M&G is one of the industry leaders in fixed income.”

The fund has a reasonable ongoing charge of 0.79 per cent, in view of its specialist mandate.

Henderson Diversified Income Trust (HDIV)

Henderson Diversified Income Trust aims to pay out at least 1.1p a quarter and has an attractive yield of over 4.5 per cent. It invests globally in fixed-income assets including government, high-yield, corporate and unrated bonds, secured loans, and asset-backed securities. It can also use derivatives and, because it has a closed-end structure, gear – take on debt – to invest more than the value of its assets in markets. This can boost returns in rising markets but detract from them when they are falling. 

The trust is run by experienced managers John Patullo and Jenna Barnard, co-heads of strategic fixed income at Janus Henderson Investors.

“Henderson Diversified Income is managed by an experienced and well-regarded team of fixed-income investors,” say analysts at Winterflood. “The managers' view is, and has been for some time, that we are late in the cycle and further interest rate hikes in the US are unlikely. With this in mind, [they] expect a continuation of the low inflation environment and low interest rates, which is reflected in the US Federal Reserve’s decision to cut rates by 25 basis points [in July]. The managers’ conviction on rates has allowed them to position the portfolio with a Federal Reserve rate cut in mind, through a high allocation to fixed-rate coupons and steps to increase the portfolio’s duration. The [trust] is positioned well for further cuts in rates given its high allocation to fixed-interest securities.”

Over one year to 31 July the trust made a NAV total return of 8 per cent, ahead of most of its listed debt peers and the IA Sterling Strategic Bond sector average.

At the end of August the trust was trading at a premium to NAV of over 4.8 per cent. Although it typically trades at a premium, it is usually a bit lower than this, so if you plan to add money to this trust maybe watch for moments when it is on a lower rating – as long as this is not because there is a problem with it.

The trust’s ongoing charge of 0.89 per cent makes it one of the cheapest listed debt funds.

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.

At the end of June about two-thirds of its assets were in high-yield debt securities, with a further 8 per cent in unrated assets, which have the potential to deliver a greater income but are considered to be higher risk. So this is a potentially higher-return but also higher-risk option.

The trust holds a core of non-financial high-yield corporate bonds issued by companies that its managers think have a low likelihood of default, alongside a smaller allocation to holdings that they think are more speculative. They expect these securities’ returns to come from a mixture of capital appreciation and income.

This trust and Henderson Diversified Income Trust’s closed-end structure means they do not have to meet investor redemptions, so any exposure to assets that are less easy to buy and sell should be less problematic than for a daily dealing fund.

FUNDS DROPPED:

Fidelity Strategic Bond (GB00B469J896)

Ian Spreadbury, veteran bond investor and manager of Fidelity Strategic Bond retired at the end of last year. The fund is now run by Timothy Foster and Claudio Ferrarese who have worked on it since 2017, and have 14 and 13 years of investment experience, respectively. 

It is too early to say how the fund will do under these managers and it has underperformed the IA Sterling Strategic Bond sector average in each of the past four calendar years. Three of the panellists who reviewed open-ended funds suggested dropping Fidelity Strategic Bond.

So while we are not advocating that existing investors sell their holding in it, for now we are removing it from the IC Top 100 Funds.

Schroder High Yield Opportunities (GB00B5143284)

Last year Michael Scott, manager of Schroder High Yield Opportunities, left Schroders to join Man GLG. Mr Scott had been lead manager of Schroder High Yield Opportunities since August 2012, during which period the fund delivered strong total returns.

Although Schroders has a strong credit team that continues to use the same investment process it is not clear how much of the fund's success was down to its previous manager or the team's approach.