Confused about the bond bubble? You should be - even the professionals can't agree on whether the asset is toxic.
Most bond investors professional or private do agree that it is difficult to find well-priced corporate debt however. After topping the popularity charts for most of 2011 and 2012, corporate bond funds reached maximum capacity.
Such was the demand for corporate debt that in July last year, fixed interest specialists M&G had to turn down a £1 billion institutional mandate as they simply had nowhere to put the cash. The asset manager also warned advisers off recommending their £6 billion Corporate Bond fund.
Looking elsewhere in the asset class, gilts have had a pretty torrid time over the last five years - after yields fell so low they offered negative real rates, yields then climbed again resulting in capital losses.
Income seekers looking for equity-like yields are then forced up the risk scale to high yield, non-investment grade 'junk' bonds - completely unsuitable for a cautious investor. Add to this the asset class' sensitivity to the economy and it begins to look unappealing.
But despite these concerns, bonds play a vital part in an investment portfolio - providing balance to equities. And although you can lose capital if you sell a bond before redemption, the income is stable - unlike a share's dividend.
So where should your bond allocation be invested?
Ian Spreadbury runs the £3.2 billion Fidelity Moneybuilder Income fund, one of the largest corporate bond fund in Britain and the company's strategic bond fund.
"Although there seems to be momentum behind the sell-off in gilts, there is a limit to how far yields can rise before they start hurting the recovery. I’m currently underweight in my funds," he said.
"I still remain positive on corporate bonds and expect them to deliver a positive return for the year. You’re getting paid for price volatility and poor market liquidity. The question for a fund like Fidelity MoneyBuilder Income is how do you protect against downside risk in the economy? I still believe focusing on non-cyclical sectors and avoiding over-concentration in financials is the best way.”
Perfecting the balance of high yield gilts and corporate debt is time consuming, and out of reach for most private investors. For this reason Darius McDermott of Chelsea Financial Services said that he favours a strategic bond fund, where the manager has a broad remit to invest across the asset class.
"A strategic bond fund can invest not only in corporate bonds and higher yielding, so-called junk bonds, but it can also invest in cash," he said.
"They can also use certain other instruments, derivatives to move the duration, which is the exposure to interest rate risk. So if interest rates go up and the fund manager has very little duration in his portfolio, he won't then suffer the same capital losses that funds that don't have that same level of powers to do."
McDermott tipped the Henderson Strategic Bond fund (
Morningstar Analyst Silver rated) and Invesco Perpetual Monthly Income Plus ( Gold rated).
Other strategic bond funds that have been awarded a Morningstar Analyst Rating include Artemis Strategic Bond ( Silver rated), Cazenove Strategic Bond ( Bronze rated) and Fidelity Strategic Bond ( Silver rated).
