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Tap bond income with Royal London Sterling Extra Yield Bond

One option for income hunters
October 1, 2020

A combination of market volatility and mass dividend cuts has cast fresh light on bonds as a source of income in 2020. Initially caught out in the Covid-19 sell-off earlier this year, the yields on corporate bonds moved out to attractive levels amid the volatility and could potentially replace some of the income lost in the equity space.

Tip style
Income
Risk rating
High
Timescale
Long Term
Bull points

Attractive yield

Flexible approach

Experienced team

Strong track record

Bear points

High risks

As with many high-yielding assets, bonds that provide a good level of income do come with significant risks. High-yield bonds, for example, are highly correlated to moves in the equity market, and the companies issuing the debt are at risk of defaulting on their obligations in times of economic difficulty. In this context, higher bond yields are best accessed via a flexible fund that can invest across the fixed income universe and even take more defensive positions where required.

Not all flexible bond funds focus on income, but some have done so with strong results in recent years. One that stands out is Royal London Sterling Extra Yield Bond (IE0032571485).

The fund, managed by Eric Holt and Rachid Semaoune, targets a high level of income, specifically looking to generate a gross redemption yield of 1.25 times that of the FTSE Actuaries British Government 15 Year index. This yield varies across the fund’s different share classes, but came to around 5.5 per cent in most cases at the end of August.

 

The fund’s remit allows it to focus on a “broad spectrum” of bonds, encompassing government debt, investment grade bonds, high-yield and unrated bonds, but the search for yield does lead it into racier parts of the market. A breakdown of the fund’s asset allocation at the end of August shows that it had just 2.3 per cent of assets in those bonds with the highest credit ratings. BBB-rated bonds, or the lowest rung of investment grade, made up around a quarter of the fund. High yield represented 41 per cent of assets, with 29.9 per cent in unrated bonds.

Importantly, the fund’s managers focus on mitigating the risks of this approach via diversification and other techniques. The fund held 221 bonds at the end of August, with even its biggest positions looking fairly limited in size. Its largest position, in a bond from Co-operative Group, made up just 2.7 per cent of assets. The top 10 holdings represented a fifth of the fund.

The managers have focused on a variety of different sectors, with a quarter of assets in banks and financial services, 13.7 per cent in insurance and 18.2 per cent in general industrials. The fund also has some exposure in foreign currencies, although a portion of this is hedged back to sterling.

Other characteristics of the team's approach, such as a preference for bonds secured against assets, should offset some of the risks involved. The managers also keep an eye on valuations, looking for corporate bonds whose price and yield offers “sufficient compensation” for risks such as a company defaulting on its debt or liquidity issues.

This fund is heavily exposed to more volatile parts of the bond market, and not one for the faint-hearted. Big allocations to areas such as high yield leave it vulnerable at points of equity market volatility, and the fund has struggled against its peers in the last year. But Mr Holt, who has worked on the fund since 2003, has successfully generated a good income, and strong total returns, over the longer term.

This fund is not without its risks, but its flexibility and experienced team should appeal to investors willing to back a racier holding in the search for income. Buy. DB

 

Royal London Sterling Extra Yield Bond (IE0032571485)    
Price96.17pSharpe ratio0.22 
IA SectorSterling Strategic BondStandard deviation6.52% 
Fund typeOpen ended investment companyOngoing charge0.84% 
Fund size£1.91bnYield5.30% 
No of holdings221More detailsrlam.co.uk 
Set-up date11 April 2003   
Manager start dateEric Holt: 11/04/03   
     
Source: Morningstar, 30/09/20    
     
     
Performance1-year total return (%)3-year cumulative total return (%)5-year cumulative total return (%)10-year cumulative total return (%)
Royal London Sterling Extra Yield Bond-3.357.0932.38112.77
FTSE Actuaries UK Conventional Gilts Over 15 Year index6.3732.6552.39131.68
IA Sterling Strategic Bond sector average3.5310.723.7254.99
     
Source: FE Analytics, 29/09/20    
     
Credit quality breakdown (%)    
     
AAA/AA/A2.3%   
BBB26.7%   
BB or below41.0%   
Unrated29.9%   
     
Source: RLAM, 31/08/20    
     
Sector weightings (%)    
     
Banks and financial services26.0%   
General industrials18.2%   
Structured14.7%   
Insurance13.7%   
Utilities9.7%   
Consumer services7.9%   
Real estate4.9%   
Sovereigns1.9%   
Consumer goods1.7%   
Telecoms1.3%   
     
Source: RLAM, 31/08/20