Strategic bond funds remain in favour despite concerns on bonds

But in February 2018 there were negative net sales for the Sterling Corporate Bond sector of £274m, Global Bonds sector of £116m, Sterling High Yield sector of £47m, UK Gilts sector of £5m and Global Emerging Markets Bond sector of £4m.

Reasons for caution on bonds included concern at the end of January that inflation in the US would rise faster than anticipated, meaning the US Federal Reserve would raise rates faster than markets expected. Years of loose monetary policy also mean that bonds are more expensive, so higher-quality ones do not offer very high yields. This means that investors in these bonds are taking on more risk for not much more reward than they could get from cash. And with interest rates rising in the US, and likely to follow in the UK, bond prices might fall – especially those of lower-yielding, safer government and higher-quality corporate bonds.

However, the UK Index Linked Gilts sector had net retail sales of £11m and the Sterling Strategic Bond sector, with net retail sales of £346m, was the best-selling sector in February. But this was down on the £808m net retail sales Sterling Strategic Bond made in January when it was also the best-selling sector, and £333m in December 2017.

The relative popularity of Sterling Strategic Bond funds is because they are probably the best option in the debt space at the moment. Their managers have the freedom to allocate to all sorts of debt, including higher-yielding bonds, loans and floating rate securities. This means they have greater ability to stay ahead of interest rate and inflation rises and, crucially, avoid problematic areas of fixed interest and debt. They can also use derivatives to try to mitigate downside.

But strategic bond funds are not suitable for investors with a low risk appetite or short-term time horizon because they may invest in securities with a risk profile similar to equities such as high-yield bonds and emerging markets debt. And because their managers have the flexibility to move around, their profiles can change very rapidly: a strategic bond fund might be very different in terms of its asset allocation and risk profile in six months compared with what it is today.

There is also no guarantee that the managers of strategic bond funds will allocate to the right areas of fixed income, and while derivatives can enhance returns they can also detract from them if the manager does not make the right calls.

Strategic bond funds are also fairly different to each other despite being ranked in the same sector, so before you invest in one make sure you do very thorough research on it and understand what it does.

If you have the necessary risk appetite and long-term time horizon to hold strategic bond funds options include MI TwentyFour Dynamic Bond (GB00B57TXN82), which is in the top quartile of the Sterling Strategic Bond sector in terms of performance over one, three and five years. It also has an attractive 12-month yield of about 4.9 per cent.

Jupiter Strategic Bond (GB00B544HM32) has a 12-month yield of about 4 per cent and the team that runs it is headed by an experienced and well-regarded manager, Ariel Bezalel. The fund can be bought from investment platforms for a reasonable ongoing charge of 0.73 per cent. Also see the IC Top 100 Funds for further strategic bond fund suggestions.

Equity funds, meanwhile, had an outflow of £136m, their first since January 2017. UK funds overall experienced net retail outflows of £510m, and the worst-selling sector in February was UK Equity Income with an outflow of £306m. The UK All Companies and UK Smaller Companies sectors also experienced outflows of £176m and £28m, respectively.

Investors are pulling away from UK equities for reasons including concerns on the exit from the European Union next year. "Investors are still avoiding domestic equities and are likely to continue to do so – especially during periods of market volatility when their appetite for risk is likely to be lower," said Adrian Lowcock, investment director at asset manager Architas.

However, some analysts argue that the risks may be priced into UK equities. "Sentiment is already low and could get worse, but if there is a reversion to more normal sentiment [this area] could improve," said Laith Khalaf, senior analyst at Hargreaves Lansdown.  

Top five selling open-ended fund sectors in February 2018

Source: Investment Association