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How defensive is your bond fund?

Inflation is the enemy of the bond investor. We certainly saw this in the first quarter of 2021: with the prospect of rising prices dominating the agenda, government bond yields rose sharply. This hurt plenty of portfolios: having made a total return of 9 per cent in 2020, the average UK gilt fund was down by nearly 6 per cent for the first half of this year. Investment grade bond funds, which buy higher-quality corporate debt, have also taken a hit.

But, of course, not all bonds are the same. Increased appetite for riskier assets has boosted high-yield bonds, which tend to have a decent correlation to equities. This has led to an interesting divide among the more flexible bond funds: names that load up on high-yield debt in search of income have fared pretty well in the first half of this year. Funds that take a more defensive approach, often using government and investment grade corporate bonds, have had a rougher experience. The worst performer in the Investment Association Sterling Strategic Bond sector for the first half of the year, ASI Sterling Bond (GB00BWK27202), had some two-thirds of its assets in UK government bonds at the end of April. By contrast, the best performer, AXA Framlington Managed Income (GB00B54CCT91), actually had a higher allocation to equities than to government debt.

We tend to highlight flexible bond funds as a good route to the asset class, given their ability to move in and out of different parts of the market. This should prove especially important at a volatile moment for bonds – but it does raise the question of what is now a 'defensive' approach to take, and how any fund you hold is positioned.

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