They also help calm the ‘liquidity’ nerves as they have a naturally attractive liquidity profile, due to regular cashflows from maturing bonds and coupon income. This regular flow of money can also help short duration bond funds actually benefit from a rising yield environment, as money from maturing assets can be redeployed quickly, easily and with very few transaction costs, compared with those with a higher yield.
This means that, typically, short duration bonds outperform the wider market in an environment of rising government bond yields, as experienced during the ‘taper tantrum’ of 2013 and ‘Bund tantrum’ in 2015. Elite Rated AXA Sterling Credit Short Duration fund is worth a look.
There are downsides, of course. The yield on short duration bonds is very low (although still better than the base rate). So, at the other end of the spectrum, high yield is the other option. Junk bonds don’t see the same drastic effect as investment grade bonds when yields rise, as they have a natural cushion of the high yield after which they are named.
Rising inflation
Inflation is nudging up, with some commentators even predicting it could reach 3-4%, or even higher, next year in places. Inflation is, as we know, the enemy of bonds because the income paid is usually fixed at the time they are issued and high or rising inflation can erode the real return you – or your clients – receive. A higher yielding bond will mean that, even after inflation and rising rates are taken into account, there is still some yield to be taken or to keep total returns in the black.
It’s also worth remembering that looser fiscal policy can be a boon to nominal growth. We have the Autumn Statement on Wednesday and it’s likely the new Chancellor of the Exchequer, Philip Hammond, will announce the end of the age of austerity and pull some infrastructure spending out of his red briefcase. Across the pond, president-elect Trump has promised gargantuan amounts of fiscal stimulus. This should all be good news for most high yield businesses. The fact that, ultimately, uncontrolled growth will increase the risk of this all ending very badly, is a topic for another day.
Aviva High Yield Bond and Baillie Gifford High Yield Bond are the two funds on my preferred list. Or you could consider the more flexible option of TwentyFour Dynamic Bond, which strategically can focus on both higher yield and lower duration to get the best opportunities in this period of transition.
