Should bond investors worry about defaults?
The number of voices predicting a recession are growing. The UK economy contracted in the first...
Normally, when we invest in a bond, we are giving money to a government or a company as a loan and, in return, they are paying us a regular income until such time as they repay said loan.
But that’s not the case right now. Low interest rates and a 35-year bond bull market have led to ‘negative yields’ in some countries.
Let me explain. But first imagine I have big wooden spoon, and I’m now stirring the already near-boiling-point Brexit pot…: Negative yields mean bond holders now have to pay certain EU governments for the privilege of lending them their money.
Waverton European Capital Growth managers pointed out recently that, “in the Euro area, 51% of all government bond paper now has negative yields. This is particularly notable in Germany, where over 80% of the government’s debt has negative yields.”
It’s quite incredible really. But before we get all hoity-toity about it, it’s worth noting that a UK 10 year government bond yields less than 1%* today. You can get more in interest from Marcus (Goldman Sachs retail bank launched last year) and Sainsbury’s Bank, which both pay 1.5%*.
Unfortunately this is not a new phenomenon. The amount of negative-yielding government bonds outstanding until 2049 has risen by about 20% to 9 billion euros – but it is still below the 11.6 billion euros in 2016**.
Neither is this phenomenon linked solely to government bonds. According to figures from the Bloomberg Barclays Euro Aggregate Corporate Index, around 230 billion euros in corporate bonds were yielding less than 0% (if held to maturity) in the first quarter of 2019 – the highest figures since the end of 2017.
Thankfully, the bond universe is a big one, and there are still opportunities to find a decent level of income, without taking on too much extra risk. Active fund managers investing in bonds are also able to combine an income with capital growth, which means total returns can be much higher than the headline yield. Below are four funds investing in such opportunities.
This fund invests mainly in investment grade corporate bonds, but up to 20% may also be held in high yield bonds, government debt, convertibles and preference stocks. It is one of two corporate bond funds managed by Richard Woolnough, and is the slightly more flexible of the two with the ability to move away from its benchmark at times when the opportunity to add extra value arises. The fund has a total return of 21% over the past five years***.
This fund also has a flexible mandate, while manager Ben Edwards has a proven track record of consistently exploiting inefficiencies in the fixed income market. While the majority of its bonds will be investment grade with relatively high credit ratings (meaning the company is less likely to default on the loan), Ben has the ability to source other ideas from asset backed securities, high yield and unrated bonds, as well as those denominated in euros and US dollars (although these will be hedged back to sterling). It has a total return of 27.7% over the past five years***.
This fund is constructed using a total return mindset, rather than just focusing on making the most income possible. Chris will have a mixture of around 80% investment grade and 20% high yield or floating rate notes at any one time. Within the investment grade section, there will be a strong weight to gilts and supranationals (such as the European Union or the World Trade Organisation). To find his holdings, Chris uses their bespoke quant research tool Observatory. The fund will only hold a maximum of 100 stocks at any one time. Returning 17.9%^ since launch in 2015 we feel it is one of the most dependable corporate bond funds out there.
This is a high-income bond fund with a unique strategy. The idea is to invest in ‘junior debt’ – bonds that are lower down the priority list for repayment if a company goes into default – but the junior debt of investment grade companies, which allows the fund to generate a good income, whilst still keeping a high-quality portfolio. It has a low turnover strategy, as the managers’ process looks for bonds they can buy and hold for some time. It has a total return of 38.1% over the past five years***.
*Source: As at 23 May 2019
**Source: Financial Times,
***Source: FE Analytics, total returns in sterling, five years to 22 May 2019
^Source: Source: FE Analytics, total returns in sterling, 15 January 2015 to 21 May 2019