Bond fund managers reduced risk towards the end of 2017 and the start 2018. A key reason behind this was their view that market valuations were rich, and they expressed difficulty in finding bonds that were attractively priced. This is an issue that has become more and more pronounced as investors have snapped up bonds with even remotely attractive yields, driving up their prices; not to mention the impact of central banks, such as European Central Bank and Bank of England, through their bond-buying programmes.
Some funds that we cover in the more traditional Morningstar Categories, such as Sterling Corporate Bond, are running interest-rate duration – a measure of sensitivity to rate changes – at the lower end of their allowed ranges, which is not surprising given interest rates in the United States and United Kingdom are expected to move up; meanwhile, they have also reduced their credit risk profiles. Similarly, within the more unconstrained bond funds, many managers have also taken a cautious view on both interest-rate and credit risk, cutting back on both in absolute terms. We highlight some examples from our Morningstar Gold, Silver and Bronze-rated funds below.
Invesco Perpetual Corporate Bond - Gold
This fund invests primarily in British-pound-denominated investment-grade corporate bonds. Managers Paul Causer and Michael Matthews have held an underweight duration stance against the index. While they had increased the fund’s duration to around six years in the summer of 2016, they reduced it at the end of 2016 and into 2017. It stood at 4.5 years as at December 2017 compared with 8.7 years for the index.
The reduction in interest-rate sensitivity was also reflected via the fund's maturity breakdown: 36.2% of the fund was invested in bonds that matured in less than four years, compared with only 21.5% for the index. The managers had also pared back the fund’s allocation to financials, which has been a key feature in this portfolio since 2008, as credit spreads had tightened over 2017, making valuations look less appealing.
While it remained a key theme in the portfolio, exposure to financials stood at 26.1% as at December 2017 versus 31.0% a year before. Meanwhile the more liquid part of the fund’s portfolio – which includes cash, short-term debt, and government and agency bonds – had crept up from 9.2% to 15.4%.
AXA Global High Income - Bronze
AXA Global High Income, managed by James Gledhill, predominantly invests in high-yield bonds globally, usually with an 80%-20% split between the US and European allocation. The fund stands out from peers because of its preference for shorter-dated credits and CCC-rated issuers, ie. higher risk firms. While the preference for shorter-dated bonds results in the fund’s considerably lower duration versus its high-yield benchmark, its typical overweighting in CCC rated bonds against the index also means the fund usually carries more credit risk.
However, the fund's risk profile has come down recently – although it was overweight CCC rated bonds relative to the index, allocation to these had dropped to around 23% as at year-end 2017 from 30% in December 2016, compared with 12% and 14%, respectively, for the index at those points in time. Meanwhile, the portfolio's yield hit a historical low versus the index in late 2017. The fund was also broadly running lower credit risk – as measured by duration times spread – than historical levels within its exposures to both the US and Europe, with a rich high-yield market being one of the factors behind this.
BGF Fixed Income Global Opportunities - Silver
BGF Fixed Income Global Opportunities is managed by a team of four managers led by BlackRock’s CIO of fundamental fixed income, Rick Rieder. The fund's opportunity set is wide and includes traditional bond sectors like government bonds, investment-grade corporates, agency and nonagency mortgages, and other securitised debt, as well as high-yield and emerging-markets sovereign and corporate debt. That said, the managers are currently running the portfolio with a lower risk profile than in the recent past.
The fund's effective duration stood at a low 0.27 years as at January 2018, reflecting the managers' expectations of higher interest rates in 2018 in light of a synchronised global growth backdrop. Most of the fund's duration was focused on the front end of the yield curve, predominantly in the zero to three-year part of the curve.
The fund was also positioned conservatively from a credit standpoint – its investment-grade and high-yield credit allocation had come down to 11.7% and 5.9%, as at January 2018, from 22.9% and 9.1% respectively, in January 2017 as spreads had tightened. While these still provided carry – the coupon rate of the bond minus the cost of funding it – other areas that the managers favoured for their attractive carry were emerging-markets debt and securitised credit, primarily nonagency securities.
Janus Henderson Strategic Bond - Silver
Managers John Pattullo and Jenna Barnard employ a flexible and unconstrained strategy that can invest across the fixed-income spectrum – credit, gilts, loans, asset-backed securities. However, the fund has historically exhibited a bias to corporate credit risk with high-yield exposure ranging from 20% to 80% of assets and investment-grade corporates from 0% to 70% since the strategy's inception.
That said, the managers reduced the fund's credit risk over 2017 by increasing its allocation to higher-rated bonds at the cost of high-yield credit – the fund's allocation to high-yield corporates stood at 30% in January 2018 compared with 44% in January 2017 while its investment-grade corporates allocation moved up to 39% from 35%. The fund’s government-bond allocation also went up to 13% from 6% during the same period, while its duration was reduced modestly from 5.3 years to 4.6 years.
