Top 50 Funds 2022: Bonds and wealth preservation

BONDS AND WEALTH PRESERVATION

BONDS (5 FUNDS)

Bonds are notoriously weak in the face of high inflation and rising interest rates, meaning the last year - and, for UK gilt investors, recent weeks in particular – has been a trying period for the asset class. But defensive bonds could yet show their value. An uptick in yields, which move inversely to prices, has already drawn some investors back into this space, while government bonds could still rediscover their defensive qualities if we move into a painful recession.

That said, we still favour flexible bond funds with the ability to move in and out of different parts of the fixed income asset class as and when they see fit. Our selection seeks to offer bond funds with varied remits, from more defensive funds to those that target yield and capital growth.

Allianz Strategic Bond (GB00B06T9362)

Like some of the more popular equity funds, this portfolio proved to be a roaring success in the early stages of the pandemic, only to run into trouble ever since. Some savvy calls ahead of, during and after the market crash of early 2020 saw the fund make a huge return of around 30 per cent for that calendar year. It then went on to lose nearly 8 per cent in sterling terms in 2021, and is down by around 12 per cent over the first eight months of this year.

Many flexible bond funds have registered some nasty losses so far in 2022, but we should provide context on why we have backed this fund. We like the experience of former M&G manager Mike Riddell, the fact that he seeks to run a fund that will prove uncorrelated to global equity markets, and that the team has great flexibility to do this. The fund’s regular monthly updates tend to disclose big allocations to government bonds and make the portfolio look rather simplistic at a surface level. In reality, the team actually uses all manner of tools, from currency exposures to short positions on a given bond market, to take advantage of shifting macroeconomic conditions.

We still think this is an interesting fund to use as a potential diversifier, but its recent struggles are a reminder that portfolios like these depend on their managers getting macroeconomic calls – and the subsequent market reaction – right, which make them a risky proposition. Investors may therefore prefer a defensive fund that delivers in a slow and steady way, and some other names in the list might fit the bill.

Jupiter Strategic Bond (GB00BN8T5596)

A fund that can serve a variety of purposes, Jupiter Strategic Bond’s objective is to generate income with the prospect of capital growth and achieve greater total returns than its peer group average over the long term. It certainly can appeal on the income front, with its stated distribution yield at the end of July coming to around 4.5 per cent. But it may also serve as a relatively defensive holding in a portfolio if you wish to ease off on your overall level of equity-type risk.

Ariel Bezalel, the fund’s longest-serving manager, has argued that inflation should remain subdued in the longer term thanks to structural factors such as demographic shifts and the disruptive effect of technology. But last month he stated that the Federal Reserve would likely continue to raise interest rates for longer than investors expect. Ultimately, the manager thinks this would be a plus for government bonds.

“The longer the central banks pursue the end of inflation at the expense of all else, the deeper and more damaging the growth fallout, and hence the recession, becomes,” he said. “In effect, this approach coils the government bond spring to the extreme and will ensure that the snap back in yields is particularly violent when the pivot arrives.”

In terms of actual positioning, the fund has tended to have decent exposure to bonds that are, on the face of it at least, more defensive. Government bonds made up just over a quarter of the portfolio at the end of July, while around 60 per cent of the fund was held in corporate bonds, with futures and floating rate notes also featuring.

The management team does make full use of different parts of the bond universe according to their view of the risks and opportunities on offer, but the fund has also tended to use a 'barbell' strategy of mixing riskier holdings with more defensive ones. While this tends to offer good diversification, there are other teams who appear to take more high-conviction positions. To give one example, Janus Henderson Strategic Bond (GB0007502080) had around half its assets in government bonds at the end of July.

TwentyFour Dynamic Bond (GB00B57TXN82)

This fund remains an option for fixed income investors given its attractive yield and good level of diversification that stretches into some of the lesser-known corners of the bond market. The fund recently had a stated distribution yield of nearly 5.5 per cent and operates across various specialist parts of the fixed income space. It may have had a 15.4 per cent allocation to government bonds at the end of July, but it also came with decent weightings to bank debt, European high-yield bonds and asset-backed securities. While not immune to pain across the whole bond market this year, we like that it continues to generate a healthy level of income and focuses on areas not always touched by other teams.

Royal London Sterling Extra Yield Bond (IE00BJBQC361)

A flexible fund with a very distinctive remit, this is a name that focuses largely on riskier bonds in the pursuit of a high level of income. That leads it into the high-yield debt sector, but also into unrated bonds and bonds with a BBB rating, otherwise known as the lowest level of investment-grade debt. It recently came with a gross income yield of between 5.3 and 6.2 per cent, depending on share class.

We like this as an option for investors who understand the risks of chasing a higher yield, or who see the merits of high-yield bonds, which are highly sensitive to overall economic conditions but more resilient to inflation and rate rises than other forms of fixed income. And at a time when economic conditions seem to be turning for the worse, we like that this fund has the flexibility to dedicate some of its portfolio to something that might prove hardier than high yield – ie, investment-grade securities. Accordingly, the fund has fared much better than the average fund in the Investment Association’s Sterling High Yield sector so far this year, although it can also lag dedicated high-yield funds during better times for the sector.

Rathbone Ethical Bond (GB00B7FQJT36)

Dishing out a high level of income and some very strong total returns over many years, Rathbone Ethical Bond has generally been a very easy fund to vouch for. It also applies an ethical investment approach, giving it an extra selling point. Charles Stanley's Morgan describes it as a “good core bond option, including for those wishing to invest more responsibly”.

We have no reason to suspect the case for the fund has changed, and view it as a solid holding. But we should note that, like some other bond funds, it has taken a big hit so far in 2022, racking up a paper loss of nearly 16 per cent in a short space of time. Investors should remember it is not immune to the jitters in the fixed income market, and could well continue to struggle as inflation and rate rises dominate the agenda.

As with any ethical fund, it’s also worth asking how the fund’s approach gels with your personal views. Tying in with that, and worthy of comment in any case, is the fact that the fund tends to have a huge weighting to the debt of insurers and banks.

WEALTH PRESERVATION (2 FUNDS)

Funds dedicated to defending your assets have come back into the spotlight as equity markets have tumbled, but only a few names manage to act as a reliable diversifier in any consistent fashion. We have condensed this list from three portfolios to two in the hope of removing duplication – although we have also found space for a new choice.

New: Ruffer Investment Company (RICA)

“This bear market is not over, and we believe that we are entering its most dangerous phase.” So went a fresh set of bad tidings from the Ruffer team in a July update. Those words would not have cheered investors, but they do signal a sense of vigilance on the part of the investment trust's managers.

We introduce this fund to the list for two main reasons. Firstly, it has done very well at navigating the harsh equity market sell-off that has marked 2022, thanks to its combination of a small equity allocation with the likes of derivative options, and different kinds of bond and gold exposure. Secondly, that positioning stemmed from a longstanding awareness of possible threats to markets such as inflation. In short, names like Ruffer may seem unglamorous when markets are soaring but play a useful role in portfolios when stocks struggle. It remains to be seen what a torrid August for fixed income has done to NAV, but this same caveat applies to Capital Gearing Trust (CGT) and Personal Assets Trust (PNL), two that we have dropped from our selection this year.

We have consolidated our wealth preservation picks down from two to one for the sake of avoiding duplication, although we should emphasise that Capital Gearing and Personal Assets also did a good job in the first seven months of the year. A notable laggard was RIT Capital Partners (RCP) – we may well find that RIT does better if markets calm, with Ruffer then lagging.

Either way, Ruffer, Capital Gearing and Personal Assets all stand out for their use of 'conventional' assets such as bonds and gold as diversifiers, and a slow and steady approach to capital preservation.

Janus Henderson Absolute Return (GB00B5KKCX12)

A name that uses derivatives to take long and short positions and that finds itself slightly down so far in 2022, this is a fund that somewhat divides our panel. With a strong record of positive returns in most full calendar years and relative resilience when markets get volatile, some of our panellists were in favour. Others were less impressed, or at least pointed to the unwelcome fact that it comes with a performance fee structure and applies a 20 per cent charge to returns above the UK base interest rate, subject to certain criteria.

We acknowledge such concerns about the fund but like that it tends to serve as a low-volatility portfolio in which to store some cash if times get challenging. Frustrating as the performance fee is, this does serve as one other potential safe haven – free of fixed income exposure, at that – and certain investors may be willing to pay up for this.

Dropped: Capital Gearing Trust (CGT) and Personal Assets Trust (PNL)

As mentioned, these exit the list for the sake of condensing this category and opting for another choice. But we still rate these funds, and they showed their worth in the first half of 2022.