Why high yield is no longer the Wild West of bond markets
This article first appeared on portfolio-adviser.com on 17th August 2023 Higher rates and rising...
It’s certainly been a tough year for the world of fixed income, with the combination of rising inflation and global uncertainty having made them less appealing to investors.
However, this asset class still has a role to play in diversified portfolios, especially for investors that are looking to generate a steady source of reliable income.
Here we take a look at the world of strategic bonds, which enjoy plenty of flexibility as they can invest across the fixed income spectrum.
Strategic bond funds can invest across the fixed income spectrum – from more traditional government and corporate bonds at one end, to riskier, high yield names at the other. This means they are often seen as one-stop-shops for investors wanting their fund manager to have the freedom of choosing which area of fixed income is most appealing. They can increase or decrease their exposure to different bond types, depending on the global economic backdrop, political environments, and other influences.
The amounts invested in the IA Strategic Bond sector has increased over the past decade. In June 2012 there was £25.28bn assets under management*. In June this year, the figure was £36.1bn**. However, levels have reduced in recent years in line with broader investor outflows as the world wrestles with uncertainties such as Covid-19 and Russia’s invasion of Ukraine. Overall, UK savers took £4.5bn out of investment funds in June 2022, the highest monthly outflow of the year so far and the second highest on record, according to the Investment Association***.
It’s worth noting that no two funds in the IA Sterling Strategic Bond sector will be exactly the same. You will need to carry out your own research to ensure a portfolio meets your needs.
Some concentrate on generating income, while others are more concerned with capital preservation. It all depends on their stated aims and objectives. The aforementioned freedom given to the manager at the helm may also differ in terms of the bonds they can buy, their geographical focus, and the overall number of holdings.
Here we highlight three strategic bond funds that may be worth considering – and take a look at where each of them are finding opportunities.
At least 70% of this fund’s assets are invested in global fixed interest securities denominated in sterling – or hedged back to the currency – while up to 30% can be held in other assets.
In a recent fund update, the managers noted July had been “an extremely strong” month for markets, with safe haven and risk assets both staging rallies.
“Clearer prospects of a macroeconomic slowdown and the potential for a pivot from central banks have pushed government bond yields lower across the world,” they wrote. The Eurozone, they highlighted, had seen a “significant repricing” in yields as investors reassessed growth prospects, while there were also very large moves in Australian and New Zealand bonds.
Looking ahead, the managers believe we’re at the start of a sharp slowdown. “Inflation cannot be sustained without growth, and central banks will be forced to pivot,” they said.
They also believe the squeeze in the disposable incomes of consumers will slow growth and inflation. Influencing factors include the dramatic increase in commodity prices. The managers remain wary about credit. “Caution on generic corporate credit is still warranted,” they added. “We expect further volatility in risk assets to provide better opportunities in the medium term.”
M&G is one of the biggest names in the UK bond space and the aim of this fund is to provide investors with a combination of capital growth and income. Richard Woolnough, its experienced manager, has at least half the fund invested in bonds issued by governments and companies around the world, including the emerging markets.
In a recent update, he acknowledged it had been a volatile first half of the year for markets, with fixed income asset classes having produced a negative return. “Investors’ appetite for bonds had already been poor because of accelerating inflation and central bank interest rate hikes,” he said. International political developments have also weighed on market sentiment, he pointed out, although he remains “reasonably constructive” on the economy.
Richard believes there are clear challenges in the economy, with the annual rate of inflation topping his list of concerns as it continues to head upwards. “On the upside, both consumers and companies are in a solid financial position and wages are rising, helping to offset some of the inflation pressure,” he said. As a result, he believes bond default rates are unlikely to increase as much as the market is currently pricing in and this makes him comfortable to own credit. “We also believe long-term investors are currently being compensated to take credit risk,” he added.
This fund’s manager benefits from a highly flexible approach that enables him to take advantage of prevailing market conditions as they change over time. At present, the fund is heavily weighted to Europe, which has a 35.59% share or the portfolio, followed by 27.51% in the US, and 25.29% in the UK****.
In a recent fund update, the team acknowledged July was a strong month for markets, with sentiment having rebounded after a very weak June. “Overall, second quarter earnings were strong in both the US and Europe, and across financial institutions and corporates,” it pointed out.
Looking ahead, the managers expect to keep liquidity elevated to maintain flexibility, according to the update. “They will also keep credit duration close to home and ensure that credit quality is robust, as uncertainty remains elevated,” it stated. “The team will continue to conduct relative value switches as the current market volatility continues to present attractive risk-reward opportunities.”
*Source: Investment Association, sector summary, June 2012
**Source: Investment Association, sector rankings, June 2022
***Source: Investment Association, 4 August 2022
***Source: fund factsheet, 31 July 2022