But if we are coming to the end of a multi-decade bond market bull run, what are the new challenges entering this space and how nimble will the funds be?
Fixed income has delivered an unexpectedly good performance, according to Stephanie Flanders, chief market strategist for the UK and Europe at JPMorgan Asset Management.
Looking ahead, 2014 is likely to be a more balanced year than 2013 with somewhat more stable returns for fixed income assets.
“In a risk-averse world, it pays to take risks. You will lose money if you don’t do anything with it,” Flanders added.
Headwinds
"The next story is when will interest rates peak and how quickly will QE reverse to QT, or quantitive tightening," according to Neil Williams, chief economist at Hermes Fund Managers.
“I'm not sure that the market fully understands what tapering is. It’s a 3% GDP loosening, not stopping of cash. The real risk for financial markets is that central banks fall behind the curve, which is when interest rates will go up."
With regulators proceeding with caution, interest rate rises are not immediate and, at the earliest, are expected by end-2015. At this point quantitive tightening could enter the scenario. But the pathway ahead is not all that clear.
"The problem is that all the models to judge this are broken and you have to go back to basics. Long-term interest rates in the US shouldn't rise above 4.5% although there will be some overshoot in the process of removing the QE corset," Stewart Cowley, portfolio manager of the Old Mutual Global Strategic Bond Fund said.
"The emergency is over but life support is still required. It would be difficult to see official rates moving much further than 3% in the US in the next couple of years."
Short duration
How the interest rate sensitivity of bond funds is managed signals, to some extent, market expectations.
"We use interest rate futures to manage the duration of the fund," Jenna Barnard, deputy head of retail fixed income at Henderson Global Investors, said.
"This year we have seen much better value further out the yield curve (10-year and 30-year bonds) where, given the steepness of the yield curve, a fair amount of future interest rate hikes have been priced in. We are more worried about short-dated government bonds where there is less protection."
Longer-dated bonds have already been hit by the low interest rate, while shorter bonds have been anchored to the base rates.
"The shorter-dated bond market is vulnerable," according to Phil Milburn, investment manager at Kames Capital.
"The rates need to be higher before we start taking shorter duration. This will probably happen sometime in 2015, after a few rate rises when the market start to discount rises."
A time to buy?
The IMA Sterling Strategic Bond sector has seen consistent growth over the past two year. Funds under management in this sector stood at £30.2bn in February 2014, compared to £28.4bn in the first quarter 2013. In the same quarter 2012, FUM were £24.7bn.
M&G's Richard Woolnough, who manages the group's flagship products, including the £18.8bn Optimal Income Fund, believes that from a historical viewpoint, bonds look cheap.
"Bond yields are attractive compared to cash. People fear that interest rates are going up. But a steeper yield curve signals bigger returns."
Hargreaves Lansdown, which runs a fund of funds in IMA Sterling Strategic Bond peer group, takes an individual approach to figuring out what’s happening in the sector.
"We focus more on identifying the right managers to cope with the shifting sands in markets than on trying to guess what will happen next to interest rates and QE, and importantly how investors will react to such changes,” according to Lee Gardhouse, investment director at Hargreaves Lansdown.
"We have been recommending strategic funds to Hargreaves Lansdown clients, based on their flexibility, for a couple of years now. We do think they are an important part of client portfolios but not all strategic funds are the same in nature so clients need to understand what they are buying."
Shifting trend
Investor interest in bond funds is still healthy, and growing. For the next year, it does not seem likely that governments will implement measures that could tilt the balance of stabilising markets and economies. However, once the Bank of England and the Fed’s balance sheets start to shrink, there will be questions to clarify, such as whether or not the governments will sell securities to the market. This in turn could impact interest rates, but catching the markets off guard will hurt everyone, particularly central banks who have too much to lose in the game. Buying into a bond fund invested in longer duration could be an alternative to lower-yielding options, such as cash.
