Best bond funds: Fund Awards 2016

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BEST LARGER STERLING BOND FUND

GAM Star Credit Opportunities GBP

1-year return: 1%; 3-year return: 28%

For a couple of years investment commentators have been predicting doom and gloom for the bond market. The consensus view is that bond prices are expensive, evidenced by the fact that yields are near historic lows.

Central banks' economic stimulus plans - quantitative easing (QE) - have made bonds a less attractive proposition.

Under QE, central banks buy government bonds en masse; as a result, bond prices have been driven higher and yields lower. The prospect of interest rates rising from their lows sooner rather than later is another headwind for the asset class.

But it would be a mistake to write off bond funds completely, particularly when some managed to grind out strong returns during these more difficult times. The performance of GAM Star Credit Opportunities GBP catches the eye: it is another returning champion, having also won this category last year.

Browse Money Observer's 2016 Fund Awards winners
Best UK equity funds
Best global equity funds
Best regional funds
Best mixed asset funds
Best absolute return funds
Best bond funds
Best property funds
Methodology

The fund has outperformed the sterling strategic bond sector every year since launch in 2011.

Over three years to the end of March, it has returned 28 per cent - well ahead of the IA sterling strategic bond sector return of 8 per cent.

The fund aims to provide investors with a high income, currently more than 4.5 per cent, from high-quality bonds.

Manager Anthony Smouha admits these two factors sound counter-intuitive, as funds seeking to provide a higher income normally invest in higher-risk companies and countries.

However, his approach is to lend to investment-grade companies, through their 'junior' bonds, rather than the senior bonds which put holders first in line for repayment if the company goes bust.

Smouha says the way he invests is more akin to an equity fund manager's approach, because he is focusing on the health of the company.

HIGHLY COMMENDED LARGER STERLING BOND FUND

Royal London Sterling Extra Yield Bond

1-year return: -1%; 3-year return: 17%

Royal London Sterling Extra Yield certainly lives up to its name, currently offering a yield of just over 7 per cent; but this year it just falls short in this category, taking home the highly commended award. It is a previous winner, having won our best larger UK bond fund award in 2014.

The fund is managed by Eric Holt, who invests in a broad range of fixed interest securities, including investment-grade, sub-investment grade and unrated bonds. Holt's main aim is to exploit bond market inefficiencies.

Holt says his holdings in financial firms, which account for nearly 30 per cent of the portfolio, have proved a significant boon for the fund in recent years. Over three years to end-March the fund has returned 17 per cent, versus 11 per cent for the IA's sterling corporate bond fund sector.

royal-london-sterling-extra-yield-versus-morgan-stanley-sterling-corporate-bond

BEST SMALLER STERLING BOND FUND

JPMorgan Sterling Corporate Bond

1-year return: -1%; 3-year return: 15%

Although interest rates have not yet started to rise as many feared they would, bond funds are no longer the height of fashion they were a few years ago. Yet within a balanced portfolio they still play a useful role.

Our award-winning smaller sterling bond fund, JPMorgan Sterling Corporate Bond is a classic, aiming to achieve a good total return from a combination of income and capital growth by investing primarily in high-quality sterling-denominated bonds.

It has been managed since August 2013 by Andreas Michalitsianos. He points out that macroeconomic conditions are an important factor in the investment process. The condition of the broader global economy is assessed in regular meetings, and is reflected in the portfolio's positioning.

gam-star-credit-opportunities-versus-jpm-sterling-corporate-bondOther key components in the investment process are the sector strategy, which determines the industry sector weightings of the portfolio, and the security strategy, which creates a scored universe of researched, investable bond issuers to be included in the portfolio.

Michalitsianos emphasises the contribution from other members of the fixed income team: 'Our strategies are implemented using a team approach, with portfolio managers and research analysts across the group participating fully in the investment process.

'We believe this approach allows us to leverage each professional's experience and expertise, facilitates idea generation and results in superior investment portfolios.'

When deciding which bonds to buy, Michalitsianos and the team conduct in-depth analysis of each issuer's credit fundamentals as well as looking at the risks that can exist within a particular bond structure. This is to ensure they are only investing in bonds where they have a strong fundamental conviction.

HIGHLY COMMENDED SMALLER STERLING BOND FUND

Morgan Stanley Corporate Bond

1-year return: 0%; 3-year return: 15%

Highly commended for the second year in a row is Morgan Stanley Corporate Bond. Despite the group's strong worldwide brand recognition, it has a relatively low-profile presence in the UK fund industry, so this consistent performer has in the past tended to slip under investors' radar.

This could be starting to change, however, with the fund's assets under management jumping from £77 million to £147 million over the past year. But even with assets doubling it is still small enough to buy into smaller issues that the larger funds cannot access.

Over three years to the end of March, the fund is up 15 per cent, outshining the IA's sterling corporate bond sector average return of 11 per cent. The two fund managers at the helm, Richard Fordsince and Leon Grenyer, currently have a third of the portfolio invested in UK bonds.

Other top holdings include US, French and German bonds. The current yield is 3.2 per cent, lower than some rivals, but over the years it has tended to be a steadier performer.

BEST LARGER GLOBAL BOND FUND

GAM Star Credit Opportunities USD

1-year return: 2%; 3-year return: 27%

GAM's Star Credit Opportunities funds have scored a double whammy in this year's fund awards, carrying off winners' trophies in both the sterling and the global bond fund categories.

Both funds are managed according to the same philosophy, focusing on bonds issued by high-quality, predominantly investment-grade companies. They are both managed jointly by Anthony Smouha and Gregoire Mivelaz.

The managers believe their strength is their different view on bond investing compared to many other investors.

gam-star-credit-opportunities-versus-f-and-c-global-bondThey focus on the lower-rated bonds of safe companies, which have the same credit default risk as the higher-rated bonds of those companies but pay more income and 'allow more nimble interest-rate exposure management'.

According to Smouha and Mivelaz, these 'hybrid investments' offer a rich and growing opportunity set, as companies increasingly use them as a lower-cost alternative to raising equity.

When selecting stock, they undertake intensive bond research combined with 'an equity mindset', to ensure they only invest in companies with a low probability of default. They do not use derivatives except to hedge currency, and have many holdings in order to diversify risk.

In terms of geography, they generally stick to core Europe, North America, Australia and the UK, targeting global franchises within these countries, although they do have small holdings in some corporations that they like in emerging countries.

The managers point out that the financials sector comprises hundreds of banks and non-banks ranging from asset managers to insurance companies, so there is plenty of diversification.

Looking forward, they feel there continues to be an 'abundance of opportunities' and expect to able to go on delivering a good income for investors and to achieve capital gains for some years.

HIGHLY COMMENDED LARGER GLOBAL BOND FUND

Schroder ISF Global Corporate Bond

1-year return: 3%; 3-year return: 15%

Our highly commended larger fund in this category, Schroder ISF Global Corporate Bond, not only invests globally but is Luxembourg-domiciled with its managers based in the US. The lead manager is Rick Rezek, who works for Schroders in New York.

His co-manager is Wesley Sparks, Schroders' head of US taxable fixed income. Their aim is to provide investors with a combination of income and capital growth by investing in bonds issued by companies around the world.

The managers are supported by Schroders' global team of credit analysts. Bonds may be held directly or through other Schroders funds, although the fund is mainly overweight US and UK bonds in the industrial and financial sectors. Up to 20 per cent of the fund can be invested in government securities.

schroder-global-corporate0bond-versus-jpmorgan-global-bond

BEST SMALLER GLOBAL BOND FUND

F&C Global Bond

1-year return: 2%; 3-year return: 14%

F&C has done well this year to receive fund awards in two different asset classes, bonds and property. In the global bond fund category, the F&C Global Bond fund takes pride of place as best smaller fund.

It has achieved consistent returns by investing primarily in government bonds around the world, although it can also include corporate bonds to increase its yield. Current manager Sujay Shah has been in charge since September 2014.

Shah's approach to picking stock for the fund involves looking at three aspects of the bond market - fundamentals, valuation and technicals.

In the case of fundamentals, he explains: 'We look at what the economic data is telling us and our expectations of how that data will evolve in the short and medium term. This informs our view of the fair value of the bonds in question.'

The second aspect is valuation, where Shah looks at the deviation between current market pricing and his own fair value forecasts, as well as the reasons for the divergence and how long it is expected to continue.

In the case of technicals, factors such as risk sentiment, supply, demand and positioning indicators are taken into account.

But, he says, 'risk is of paramount importance'. Portfolio risk levels are consistently monitored and reviewed ahead of data and events.

He says: 'Regular portfolio construction meetings take place, whereby we apply scenario analysis to shock the portfolio based on specific risk events - either ones that have taken place previously in history, or hypothetical scenarios.' In response, he may increase or lower the risk in the portfolio.

Shah is relatively cautious on the prospects for global government bonds, with the US market set to remain uncertain. On the other hand, he believes that government bonds in Europe look relatively well-supported.

HIGHLY COMMENDED SMALLER GLOBAL BOND FUND

JPMorgan Global Ex UK Bond

1-year return: 2%; 3-year return: 12%

JPMorgan's fixed interest team has scored a second accolade in our fund awards, with highly commended status in the smaller global bond fund category going to JPMorgan Global ex UK Bond (adding to the trophy the team received in the sterling bond category).

This fund has been managed since 2008 by David Tan, the firm's London-based global head of rates, with Dirk Frohnert joining him as co-manager in 2015.

Although the fund can invest anywhere in the world in corporate or government bonds, its main focus is on government bonds. Over 70 per cent of the portfolio was recently invested in these bonds, including bonds of emerging countries as well as developed economies.

Although the latter have predominated recently, with Japanese and US bonds among the top exposures, the fund has also had stakes in bonds issued in Mexico and Qatar.

However, Tan monitors credit risk carefully as he points out that, unlike shares, the 'upside' for bonds is usually limited, whereas the 'downside' can be significant.

BEST ETHICAL BOND FUND

Rathbone Ethical Bond

1-year return: -1%; 3-year return: 16%

Rathbone Ethical Bond is another returning winner, having won this category in 2015. The fund aims to produce a 5 to 7 per cent gross interest yield, with an emphasis on investment grade bonds. The current yield is 4.7 per cent, and income is paid quarterly.

The fund applies negative screening criteria to exclude issuers of corporate bonds in breach of the exclusion criteria.

rathbone-ethical-bond-performanceBonds of companies involved in a range of activities, from producing alcohol to issues that involve the use of animal testing, are ruled out. Bond issuers involved in pornography or tobacco are also excluded.

To win a spot in the portfolio there are certain criteria to be met. For instance, companies should have progressive policies in relation to such things as human rights and the environment.

Jones acknowledges the challenges ahead for bonds, but thinks the fund will continue to deliver a high level of income for investors. 'We think the fund's circa 5 per cent yield is very attractive for an investment-grade product, particularly in this low-income environment,' he says.

Although the fund can invest internationally, Jones keeps at least 80 per cent in investment-grade UK bonds. Up to 10 per cent can go into non- and lower-rated bonds.


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