by Dewi John.
Sterling Strategic Bond is supposed to be the SUV sector of the fixed income fund world—it can go anywhere, unconstrained by region, duration, or credit quality. This allows the active manager to go where they feel the best opportunities lie and avoid those areas of the bond market they reckon are best avoided—conceivably, they can invest everything from UK gilts through to European high yield. Unlike, for example, a UK corporate bond manager, who if they don’t fancy the prospects for UK corporate bonds…well, tough—Burger King is hiring.
On that basis, it’s a sector that’s done well in attracting assets—particularly those of the retail investor, who will want to leave the intricacies of the bond world to a trusted manager, rather than worry about whether now is the time to go overweight Asian high yield. There is more than £100bn of UK investor cash entrusted to managers in the sector, compared to £62bn in Sterling Corporate Bond or £30.5bn in US government bonds.
That said, over 12 months to the end of January, the sector suffered outflows of more than £8bn (as opposed to the, albeit modest, inflows for sterling corporate bonds of £394m over the same period)—although this has been reversed over the past three months, with inflows of £2.6bn, compared to £1.4bn for sterling corporates.
Yields have rebounded over the past year, making bonds more attractive. But this bounce has been on the back of negative performance, as rising rates punctured bond valuations. In comparison to the sterling corporate bond and UK gilt sectors—down 11% and 19.3%, respectively—over the 12 months to the end of January, the strategic bond sector has fared rather better—losing only 6.6%. That said, the global government bond sector is down 4% and global high yield up 1.8%. But, on average, the strategic sector would be expected to avoid the worst pitfalls rather than all the funds calling all the shots right.
One vital question for fixed income is “are we there yet?” In this instance, “there” pertains to the terminal rate, the level at which base rates peak. This is important, because rising rates gouge a hole in bond returns, and we may have further to go. After the last rate rise to 4%, monetary policy committee member Catherine Mann said, “Uncertainty around turning points should not motivate a wait-and-see approach, as the consequences of under tightening far outweigh, in my opinion, the alternative. We need to stay the course, and in my view the next step in Bank Rate is still more likely to be another hike than a cut or hold.” That being the case, there is more money to be lost in this asset class.
This can be mitigated through shortening the duration of a fixed-income portfolio, duration being the sensitivity of bonds to rates (the longer, the more sensitive). Given the flexibility of Strategic Bond, managers have a wider universe to implement duration plays. What’s interesting, then, is that the sector’s average duration finished 2022 higher than it started—peaking in July. This, however, is still lower than Lipper classifications Bond GBP Corporates and Bond USD Corporates, though these have noticeably trended down over the same period. But, overall, there’s little sign that at a time when duration has overwhelmed bond returns this doesn’t seem to have been a management strategy that has characterised the sector as a whole.
The sector funds’ 12-month performance goes from 7.5% to -19.8%, with the three-year return range stretching from 15.5% to -23.6%. The top-performer over this period is the Merian Global Strategic Bond fund. Somewhat unusually compared to other bond funds, it’s decreased its exposure to investment-grade bonds from nearly 80% in March 2020 down to about 60% in October 2022.
The second-placed Legal & General Strategic Bond fund has had slightly more than half its portfolio in investment-grade paper, increasing from about 32% from three years ago. Over the past three years, it’s noticeably increased its weighting to developed-market securities.
If bonds are coming back into vogue, we’d expect this sector to be a significant beneficiary.
Table 1: Top-Performing Sterling Strategic Bond Over Three Years (with a minimum five-year history)
All data as of January 31, 2023; Calculations in GBP
Source: Refinitiv Lipper
This article first appeared in the November issue of Moneyfacts, page 13.
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