Top 50 Funds 2021: Bonds

Many investors’ portfolios should have an allocation to assets other than equities for diversification. And with cash rates so low bonds can be a useful component in income portfolios. But although bonds can be less volatile than equities they are far from risk-free, so you need to be selective about the types of bond funds you invest in. For this reason, we mainly include 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.

Allianz Strategic Bond (GB00B06T9362)

Government bonds have had quite the ride in 2021, selling off heavily in the first quarter before recovering strongly in the summer. With government bonds in particular looking vulnerable to the threat of inflation, we continue to favour flexible bond funds as a potential diversifier to equities.

These include Allianz Strategic Bond fund, which struggled this year after posting an astonishing return of 31 per cent in 2020. Yet this is still a good option due to its flexible investment approach. Its manager, Mike Riddell, uses a variety of tools, from government and corporate bonds to currency exposures and derivatives, to provide genuine diversification to equity markets.

It can be difficult to understand exactly what is happening in the fund from its factsheets alone, but it has a good record of protecting investors' money at points of equity market volatility such as during the sell-offs in early 2020 and final quarter of 2018.

Towards the end of July, Riddell noted he had seen no signs of longer-term inflationary pressures. At the time, he was cutting exposure to government bonds in the wake of strong performance. Riddell and his team’s “highest conviction views” were that currencies and local currency government bonds in emerging markets looked relatively cheap, while corporate bonds in developed markets looked “exceptionally expensive”.

See 'How bond funds are facing the inflation threat' (IC, 06.08.21) for further details on how strategic bond funds were positioned for an inflation threat in summer 2021.

Jupiter Strategic Bond (GB00BN8T5596)

The largest fund in the Investment Assocation (IA) Sterling Strategic Bond sector, Jupiter Strategic Bond seeks to provide income with the prospect of capital growth and had an attractive distribution yield of 3.6 per cent at the end of July. That said, its investment team takes a relatively cautious approach, making good use of more defensive debt alongside riskier bonds. Jupiter’s head of strategy for fixed income, Ariel Bezalel, has long argued that interest rates will be lower for longer, with inflationary pressures kept in check over the longer term by factors including high levels of global debt, ageing demographics, and disruption from globalisation, technology and low-cost labour. So he tends to take a flexible, “barbell” approach when running this fund with a mixture of different exposures.

The fund has had a mixed record during periods of market volatility, performing strongly in the final quarter of 2018 but taking a hit in the 2020 sell-off. But Jupiter Strategic Bond can be a good compromise between seeking income and looking to manage risks.

MI TwentyFour Dynamic Bond (GB00B57TXN82)

Another option that might appeal to income investors is MI TwentyFour Dynamic Bond, which had a distribution yield of 4.15 per cent at the end of July. But this strategic bond fund also stands out because of its flexibility: its investments span various corners of the fixed-income market, from government bonds to high yield, financial debt, asset-backed securities and emerging market debt.

It has fared less well than Allianz Strategic Bond and Jupiter Strategic Bond in recent major equity sell-offs, but may present an interesting option for investors worried about the outlook for government bonds. MI TwentyFour Dynamic Bond had just 16 per cent of its assets in government bonds at the end of July, and notable exposure to debt issued by banks and insurers.

As of summer of 2021, the fund's investment team appeared more concerned about the longer-term prospect of inflation than the managers of Allianz Strategic Bond and Jupiter Strategic Bond. MI TwentyFour Dynamic Bond's managers were notably upbeat on the outlook for corporate bonds at the time.

Royal London Sterling Extra Yield Bond (IE00BJBQC361)

A punchier option when it comes to strategic bond funds, Royal London Sterling Extra Yield Bond holds riskier bonds in the pursuit of a high income. A good 43 per cent of its assets were in riskier high-yield bonds at the end of July and the fund offered a gross income yield of between 4.33 and 5.29 per cent, depending on the share class.

With its ability to hold higher-quality bonds, Royal London Sterling Extra Yield Bond should be able to limit some of the volatility experienced by dedicated high-yield bond funds, but it will also lag some high-yield bond funds at times of strength for riskier debt.

Rathbone Ethical Bond (GB00B7FQJT36)

This fund's total returns may appeal as much as its ethical slant: it has fairly consistently generated much better returns than the IA Sterling Corporate Bond sector average. The fund delivered a total return of 37.84 per cent in the five years to 27 August, making it the second-best performer out of some 90 funds in its sector.

While its managers focus on total returns rather than just income, the fund recently had an historical distribution yield of 3.2 per cent. With regard to its ethical criteria, Rathbone Greenbank assesses the fund’s potential investments using positive and negative social and environmental criteria.

As with any ethical or environmental, social and governance (ESG) fund, investors might be picky about what they view as suitable holdings. With that in mind, this fund has tended to have a significant focus on debt issued by banks and insurers, which made up more than 70 per cent of its assets at the end of July.