Concerns advisers blindly buying into strategic bonds

The return of inflows into sterling strategic bond funds has raised concerns advisers are blindly allocating money into the sector without understanding it is not just a one-stop shop for outsourcing fixed income asset allocation.

The £2.1bn Henderson Strategic Bond fund, managed by John Pattullo and Jenna Barnard, and £298m Kames Strategic Bond Fund, managed by Juan Valenzuela and Alexander Pelteshki, topped adviser sales at Fundsnetwork in May, while the Investment Association sector as a whole topped the sales table for the month.

The £3.9bn Jupiter Strategic Bond fund, managed by Ariel Bezalel, was also popular over the month, despite the offshore version being a source of outflows for the asset manager.

The sector is popular with investors who want to outsource asset allocation decisions, but that is a much too simplistic view, according to GBI2 managing director Graham Bentley.

Bentley is concerned advisers who “don’t have the investment background yet still insist on building portfolios” are blindly buying funds in the sector without understanding performance, yield and duration vary widely across the sector.

“The manager of course doesn’t know the adviser’s client and has no contract with the adviser to manage in a particular way,” Bentley says.

The £1.7bn Royal London Sterling Extra Yield fund, run by Eric Holt, has delivered 27.2% over three years, topping the sector, compared with the $70.3m BNY Mellon Global Opportunistic Bond fund, the worst performer, which has fallen 3.6% over the period, according to Trustnet.

Duration of the former is 5.5 years, while on the latter it’s 1.9 years.

AJ Bell also registered strong inflows in the Sterling Strategic Bond sector in June with Bezalel’s funds also popular with its adviser clients. Richard Woolnough’s £23.7bn behemoth of a fund, Optimal Income, also featured, alongside the £1.3bn Artemis High Income, managed by Alex Ralph.

Three buckets

AJ Bell head of active portfolios Ryan Hughes divides the Sterling Strategic Bond sector into three types of funds: defensive strategies with lots of government bonds; riskier funds with substantial allocations to high yield; and strategies that “genuinely flex between the two”, namely the outsourced asset allocation product.

According to Investment Association parameters, fund managers in the sector can invest across fixed income instruments as long as 80% of assets are sterling denominated or currency hedged.

“What’s very important is to look at the funds, understand what sort of biases they have and what asset allocation they have almost hard-coded into their fund design. Some will say they can’t have more than X% in a certain type of bond, or they’ll always have a minimum of Y% in a certain type of bond. You really need to get beneath the bonnet,” Hughes says.

Investors in any sector should understand each fund’s objective and its investment mandate, says Chase de Vere research manager Justine Fearns.

“Within the UK All Companies sector, for example, the short-term returns you may see from a large-cap, growth biased fund could be very different from that of a mid and small-biased value strategy,” Fearns says.

However, she says the Sterling Strategic Bond sector in particular can be a “melting pot”.

In-house or outsource

AJ Bell uses its own allocations to gilts, corporate bonds and high yield and therefore does not use sterling strategic bonds in its portfolios.

Hughes says: “We’re looking in each of the sub sectors to find the very best manager because we want to have our own duration and credit quality positioning.

“But I fully understand why someone would want to outsource those decisions in this current environment.”

In the corporate bond space, AJ Bell marries Ian Spreadbury’s Fidelity Moneybuilder Income fund, a defensive fund, with the TwentyFour Corporate Bond fund, which takes on more risk, he says.

Fidelity head of investment directing for European fixed income Curtis Evans says the asset manager’s funds in the Sterling Strategic Bond sector tend to attract more retail money, whereas investors in a sector like the Sterling High Yield sector tend to be “more comfortable with fixed income asset allocation”.

Fidelity offers the £1.7bn Strategic Bond and £640m Extra Income funds, both run by Spreadbury, in the sector.

Evans says the former is a “core, one-stop shop” type of product commonly associated with the sector, while the latter, as its name implies, focuses on higher-yielding credit.

Navigating the sector

Investors eyeing the Sterling Strategic Bond sector as a way to outsource fixed income investment decisions should assess performance over time and at particular points, such as the 2013 taper tantrum, Fearns says.

Further examination will then detail any investment limitations or whether the fund can use derivatives to enhance performance.

She says the Fidelity Strategic Bond fund typically holds up well in times of risk, while the Jupiter Strategic Bond fund, favoured by FundsNetwork advisers in May, actively manages duration and counterbalances high income and opportunistic strategies with capital preservation strategies.

Both funds have navigated their portfolios through various credit events, she says.

Evans warns advisers to be aware that some funds in the sector have high allocations to high yielding credit, floating rate notes and financial securities. While this reduces duration risk, it also creates portfolios more correlated to stock markets, which may not be suitable for advisers seeking equity diversification.

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