What the professionals are doing
Interestingly, while retail flows have increased into the sector significantly in the last 12 months, it seems professional fund buyers have become less interested in bond funds judging by their research habits.
In February 2015 IA Sterling Strategic Bond’s share of IA research on FE Analytics peaked at 5.07%. However, by November 2017 this dropped to a low of 3.49%, rising to 4.07% in December.
So what does Lowcock make of the popularity of the sector? “It’s interesting that people have become more interested in bonds in 2017 just as global growth is recovering and interest rates are beginning to rise – two reasons for bonds not to look so attractive,” he says.
“However, there is more going on in the bond space. With the bond bull market over as interest rates start to rise then bond investors need to be more flexible to protect capital and income and this is where strategic bonds come in as they offer the broadest exposure to the market. It means that the managers have the opportunity to take advantage of changes in bond prices and yields as the markets adjust to a rising rate environment.”
At the same time as bond yields have risen from their 2016 lows, Lowcock adds that investors who had fled into the bond proxies because of the more attractive yields are being enticed back by reasonable yields albeit with lower levels of risk.
“The challenge in 2018 is can the bond market hold up if rates are rising and has the market got it right in anticipating the general pace of rate rises in the UK and indeed the US?” he asks. “At the moment, US treasuries are a bit more nervous about rising interest rates and more importantly the effects of the withdrawal of QE and have begun to price in higher rates more accurately.
“Given the current outlook and the fact we are in a rate rise environment, bonds do look riskier than investors perhaps appreciate. In the UK a more positive outcome from Brexit negotiations and we could see growth recover more quickly and indeed further rate rises.”
Given this uncertainty, Lowcock argues strategic bonds are probably the best approach as they give the manager the flexibility to go anywhere in the bond space. His current pick in the sector is the MI TwentyFour Dynamic Bond Fund.
“This fund is run on a team basis with each member having specialisms in fixed income,” he says. “The investment committee establish the bigger picture view of the world leaving the managers to decide how and when to reflect this within the fund. The fund can go anywhere in the fixed income space and as such could be considered a best ideas portfolio.”
