Dewi John puts the all-terrain strategic bond sector through its paces
Strategic bond is the ‘go anywhere’ sector that gives its managers maximum freedom within fixed income. Given last year’s market turmoil, and with many tipping the return of inflation this year, its managers may be tempted to use every bell and whistle at their disposal.
Funds must invest at least 80% of their assets in fixed-interest securities. This must be either sterling-denominated or hedged back into sterling. Managers have more leeway than those in other bond sectors to decide the credit quality and country they invest within that 80%. They can throw the fund from 100% gilts to 100% emerging-market high yield and back again, should they choose – though few, I think, would make so bold a move.
Overall, the average strategic bond fund has behaved in the hybrid way that you might expect (Table 1). High yield has far outstripped the other bond classes over one, three and five years, being more correlated with equity returns in a period characterised by a strong rally in this asset class since the market lows last March. But it has done so with greater volatility.
UK government bonds, on the other hand, have suffered their worst quarter in two decades as investors have sold off the quintessential safe-haven asset in the hope of a UK recovery, propelled by the country’s faster vaccine rollout.
Sterling high yield, corporate and strategic bond fund average returns have beaten their global bond peers in all the time periods listed. This is despite the fact that Refinitiv Lipper classifies more than half of the funds in the sector as global bond vehicles and that seven of the top 10 performers in three years are also classified as such. So, the outperformance is likely not down to their country allocations.
Another thing to be mindful of with regards to a fund’s allocation is what is happening with that other fifth of the portfolio. The ability to put 20% of the fund in an entirely different asset class can act as a significant kicker – or completely blow out its performance – depending on which way the wind is blowing. Few managers would want to use that degree of freedom and Refinitiv Lipper would certainly consider such a fund to be a mixed asset fund, rather than a pure fixed income one. Indeed, we classify five funds in the sector as mixed asset.
The credit spectrum
Turning our attention to individual performance, the sector has delivered a wide range of returns across three years – from 40.9% to -9.9% – as you might expect from a grouping that allows such a wide range of allocations.
Leading the field is the Allianz Global Bond fund. It seems to be making good use of the sector’s freedoms. The fund’s largest country allocation in February was Japan (21.7%), followed by Canada (11.3%) and the US (9.6%). Twelve months before, it was the US, Japan and Germany, with 21%, 15.5% and 11.8% allocations, respectively. The fund also makes use of its freedom to roam around the credit spectrum. As you can see from the chart above, the percentage of investment grade – and singling out AAA-rated debt – has varied considerably through time. What’s interesting, too, is that while bond fund managers have tended to lower debt quality in the search for yield, the Allianz fund displays no clear trend towards this.
That has put the fund 14 percentage points clear of the second-placed vehicle during the period: the Aegon Strategic Bond fund. This has a very different-looking portfolio: 52.4% in investment grade bonds, with 36.4% being in BBB-rated paper (the lowest rated of investment grade). This has likely helped it during the past 12 months, when it is ranked second with a return of 26.4%. That said, the top four funds all carry a Lipper Leaders Consistent Return rating of five (the highest) across five years.
The leader during Q1 2021 was the AXA Framlington Managed Income fund, returning 3.6%. Refinitiv Lipper classes this as mixed asset GBP conservative – it had a 12.6% equity exposure as of the end of February, and its fixed income exposure has a strong and persistent bias to the UK. So, again, a very different creature to the leaders over three years.
With expectations of post-Covid-19 recovery, the coming months will likely present very different conditions. Will those managers who make use of the freedoms at their disposal be rewarded accordingly? The problem with choices, of course, is that they can always be the wrong ones.
Dewi John is head of research for Refinitiv