Cautious investors turn to bonds

Cautious investors have been putting more money into fixed income funds due to deepening fears about the global economy. These investment portfolios enjoyed inflows of £632m in May, with IA Government Bond being the top selling sector, according to the Investment Association (IA).

Here, we take a look at the renewed enthusiasm for fixed income and highlight three funds that could be worth considering.

Caution is a driving force

It’s fair to say we’re living in financially challenging times. High inflation, soaring interest rates, and global uncertainties are cranking up the anxiety. Whether or not we’re headed for a widespread recession – and opinions vary enormously on that point – many investors are trying to play it safe.

This is why caution was the theme of the month during May, according to Chris Cummings, the IA’s chief executive, with government bonds enjoying particularly strong inflows.

“This is not surprising given concern about potential global recession and ongoing conflict in Ukraine,” he said.

Benefits of bonds

Before we highlight some bond funds that might fit the bill, let’s consider why investors could be drawn to fixed income in the first place.

The main point is that exposure to bonds should lower the overall risk of your portfolio, as well as (hopefully) giving you a predictable income stream. However, bonds vary enormously in terms of their exposure to particular markets, the risks they take, and the likely returns you may enjoy. For example, prospective investors in this area will need to consider whether they want a portfolio full of government bonds, corporate bonds, or a combination of both.

Problems being encountered

They will also need to consider the economic backdrop. What is happening to inflation? Will interest rates rise from here? How are the various asset classes being affected?

Taming stubborn inflation is proving to be a “Herculean task for policy makers”, according to a recent insight from Jupiter Asset Management. “That in turn is making reading the direction of the fixed income markets extremely difficult for investors,” it read. “There’s been little respite from volatility in fixed income this year too unlike other asset classes.” The update noted how core inflation had stayed at elevated levels due to the imbalance between demand and supply.

“Until inflation falls to acceptable levels, interest rates will remain elevated, which means positioning will continue to be on a knife’s edge,” it concluded. “In this context, staying low duration and being flexible may help in overcoming any near-term challenges.”

Where to invest?

So, which part of the fixed income universe should you consider? Well, you need to be selective, according to Morgan Stanley’s midyear investment outlook. It suggested that long-duration government bonds in the US, UK and Germany could perform well, with attractive real yields, despite the high inflation. “Meanwhile, soft economic growth without a recession in developed markets suggests that investment-grade bonds could be defensive and provide positive returns,” it added.

The good news is there are plenty of bond funds that can give you exposure to different parts of the fixed income universe. Here are four portfolios we believe are worth considering.

Our first suggestion is the M&G Global Macro Bond fund, which is managed by the experienced Jim Leaviss, who has been involved in fixed income for more than two decades.

This is a go-anywhere fund that can invest in any bond issued by a government or company around the world. This gives Jim plenty of scope.

According to the most recent factsheet, almost 40% of the portfolio is exposed to the US, with 13.5% in UK names*. Other countries represented include Germany, Japan, France and Spain*. On a bond quality standpoint, those AA-rated or above account for 56% of assets.

Our next fund suggestion is Jupiter Strategic Bond, which is another flexible, go-anywhere fund that gives managers Ariel Bezalel and Harry Richards plenty of freedom. For example, the unconstrained mandate means they’re not tied to a benchmark. This enables them to shift allocation between government, investment grade and high yield bonds.

Their goal is to find the most attractive investment opportunities – wherever they happen to be in the world – that will help the fund achieve a moderate income and the prospect of growth. We like how the fund has focussed on controlling the downside, enabling it to achieve some exceptional risk-adjusted returns. This also helps mark it out from the pack.

Then we have the Baillie Gifford Strategic Bond fund, which offers exposure to a concentrated portfolio of primarily UK fixed income securities. Its managers, Torcail Stewart and Lesley Dunn, aim to produce a monthly income, as well as opportunities for capital growth.

They will aim to add value almost exclusively through their stock-picking prowess, rather than aggressively manage the interest rate exposure. This sets them apart from many rivals.

The managers currently have broad diversification when it comes to sectors, with banking the most prominent with 14.6% of the fund, followed by the 10.3% in financial services*.

Our final suggestion is GAM Star Credit Opportunities, which is run by the highly experienced pairing of Anthony Smouha and Gregoire Mivelaz. The fund, which aims to generate steady, high income from the bonds of quality companies, has a low turnover as it favours a buy-and-hold approach.

It also focuses on junior – or subordinated – debt, which enables a good income to be generated, while a high quality portfolio is maintained.  The fund is also heavily exposed to the debt of financial companies because this is where it’s been finding the best opportunities at present.

You can watch our most recent interview with manager Torcail Stewart of the Baillie Gifford Strategic Bond fund here.

*Source: fund factsheet, 31 May 2023