Assessing bond risk in your core fund holdings

Inflation continues to bite, interest rates continue to rise and life remains uncomfortable for bond investors. The Financial Times notes that the US government bond market recently endured its worst month since Donald Trump’s 2016 election victory sent yields spiking, and the pain of those falling bond prices has been felt elsewhere. The average fund in the Investment Association UK Gilts sector is down by nearly 7 per cent over the year to 24 March – and by an equivalent amount so far this year – with higher-quality corporate bond funds also taking a hit. While this isn't as bad as the large falls seen in certain pockets of the equity universe, it’s an unwelcome development for those relying on bonds as diversifiers.

This is an issue for the multi-asset funds many investors use as the core of their portfolios. High-profile, widely-held funds such as those in Vanguard’s LifeStrategy* range restrict themselves to using equities and bonds, and that has hurt performance for the more bond-heavy ones over recent months.

Over the three months to 24 March, MSCI World index racked up a sterling paper loss of 4.3 per cent and Vanguard LifeStrategy funds with higher bond exposure were also punished. Vanguard LifeStrategy 20% Equity (GB00B4NXY349), with 80 per cent of its assets in bonds, is down by nearly 6 per cent over that period, with slightly less heavy losses for its more equity-heavy siblings. A similar pattern can be seen in the Liontrust Sustainable Future range, where funds with greater reliance on bonds such as Liontrust Sustainable Future Defensive Managed (GB00BMN90635) have fared worse than funds from the same range with a bigger equity focus.

Some investors will be tempted to simply ride out the storm, or hope that inflation and monetary tightening tail off and government bonds reassert themselves as a safe-haven asset class. Likewise, some could simply offset bond exposure by adding to more inflation-resistant assets elsewhere in a portfolio, from property and infrastructure to commodity exposure. But for those seeking a different type of multi-asset fund, a handful of conventional multi-asset funds look beyond equities and fixed income, albeit often in fairly conventional fashion.

Beyond bonds?

Some more direct rivals to the likes of the Vanguard LifeStrategy funds go beyond bonds in their quest for diversification, but only to a limited extent. Take the MyMap range launched by BlackRock in 2019: while touted as having a wider spread of investments than peers at the time of launch, its funds have only tended to have very small allocations to alternatives. Other rivals do go slightly further afield, but even these ambitions are limited in the case of strategies that seek lower-risk approaches.

The Legal & General Multi-Index range, which uses in-house funds to express asset allocation calls, features some alternatives. Legal & General Multi-Index 3 (GB00B9751744), the fund with the lowest risk rating and the greatest need for defensive assets, had 9.5 per cent of its assets in alternatives at the end of January, an allocation that included listed infrastructure, property & real estate, commodities and forestry.

The fund had 16 per cent of its assets in cash at the time, with 26.5 per cent in different government bonds, the same amount in corporate and emerging market debt, and 21.5 per cent in equities. Speaking to FT Group publication Asset Allocator in February, Justin Onuekwusi, who manages the fund range, suggested that a scenario of higher inflation and rising interest rates could create “the worst nightmare for a multi-asset portfolio”, of bonds and equities falling in tandem. But he added that “co-behaviours” could be more important than asset class correlations – pointing to the similar behaviour of interest-rate-sensitive assets at moments of tightening monetary policy.

Meanwhile, Royal London GMAP Defensive (GB00BD8RSJ84) does make substantial use of bonds, but also had a 7.2 per cent allocation to commodities at the end of January, with 5.5 per cent in UK property.

Elsewhere, a multi-asset range run by Rathbones has also sought some differentiation. Sticking with funds further down the risk spectrum, Rathbone Total Return Portfolio (GB00B8JBXD38) managers David Coombs and Will McIntosh-Whyte have turned to the likes of commodities in the recent past. They had a 7.5 per cent allocation to commodities at the end of February, with 5.8 per cent in alternatives, 6.2 per cent in cash and a very small weighting to private equity. Conventional government bonds made up 22.6 per cent of the fund. Another lower-risk option, Premier Miton Defensive Multi Asset (GB00B0525B66), has also made use of assets viewed as inflation hedges, with an 8.1 per cent commodities weighting at the end of February.

Punchier options

The Royal London, Rathbone and Premier Miton funds sit in the IA Mixed Investment 0-35% Shares sector, which as the name suggests caps equity exposure at around a third of a fund. Moving up the risk spectrum, and we find some other multi-asset funds that have dipped a toe into the alternatives space.

In the IA Mixed Investment 20-60% Shares sector (where constituents must have between 20 and 60 per cent of assets in equities), funds such as Schroder MM Diversity (GB00B60CZD52) stand out for looking beyond traditional asset classes. The fund had just 16 per cent of its assets in bonds at the end of January, with a third in alternatives.

Prominent holdings in this fund-of-funds include Majedie Tortoise, a long/short global equity fund that isn't usually available to private investors, and absolute return funds such as Man GLG Absolute Value (GB00BF1X8084). The fund has also used some value-minded UK equity vehicles such as Jupiter UK Special Situations (GB00B4KL9F89). Like some of the other multi-asset funds, Schroder MM Diversity had a chunky stated allocation to cash.

Another fund in the IA Mixed Investment 20-60% Shares sector, MI Hawksmoor Vanbrugh (GB00B55LY991), had just 6.7 per cent of its assets in government bonds at the end of February, while around a quarter of the portfolio was in different forms of fixed income. When it comes to alternatives, some 24 per cent of the portfolio sat in real assets, with nearly 10 per cent in resources including precious metals. The fund also makes some use of private equity vehicles such as Oakley Capital Investments (OCI).

Looking at even riskier multi-asset funds, a good number have made use of alternatives in recent times. For example, Royal London GMAP Adventurous (GB00BD8RSG53), which sits in the IA Mixed Investment 40-85% Shares sector, had a 16.9 per cent allocation to UK property and 7.2 per cent in commodities at the end of January.

Having said that, the ability of riskier multi-asset funds to load up on shares means that equity exposures, rather than diversifiers, hold more sway over performance in this part of the market. It's notable that Vanguard LifeStrategy 80% Equity (GB00B4PQW151) is among the better performers from its sector over the past year. That said, this is likely a reflection of the fact that some rivals in the sector will simply have lower allocations to equities.

*The writer holds one of these funds