UK investors have flocked to government bonds this year as they have provided safety in a volatile environment. But yields are negligible and in some cases negative: currently a UK Government 10-year Gilt yields 0.18%, while the two and five-year gilts are negative. On top of that, the popularity of bonds means that prices have been driven up to new highs, so those investors buying the two, five and 10-year gilts and holding to maturity are guaranteed to make a capital loss. So you are effectively paying to lend to the British government.
Where does that leave investors who want exposure to fixed-income in their portfolio? One way is to go down the active route and choose a fund that manages that risk for you, and tries to achieve a decent yield while maintaining bonds’ traditional capital preservation benefits.
We have picked three bond funds, one with a UK mandate, one that has a global remit and one that covers emerging markets.
UK – Allianz Gilt Yield – Silver
The clean I share class for this fund has a Morningstar Analyst Rating of Silver and it aims to outperform the FTSE Actuaries UK Conventional Gilts All Stocks Index over a three-to-four-year horizon. Analyst Louise Babin says the fund’s manager Mike Riddell has proven his ability to add value in a range of market conditions, and the fund is the most flexible of those in the Morningstar Sterling Government Bond category. Year to date the fund is up nearly 10%, beating both category and benchmark, and has returned over 6% on an annualised basis over three years. Its 12-month yield is a touch over 1%. The fund mainly invests in UK Government debt, with exposure to other forms of bonds limited to 20% - this part of the portfolio can contain US Treasuries, inflation-linked bonds and the government bonds of non-UK countries. Recent exposure to “supranational bonds”, such as those issued by the European Investmant Bank, has paid off, says Babin.
Global – BNY Mellon International Bond - Bronze
Our choice of global bond fund is Bronze-rated BNY Mellon International Bond, which has returned over 11% in the year to date and over 8% on an annualised basis over five years, according to Morningstar Direct data. The 12-month yield is 1.30% and the fund’s biggest holdings are US Treasuries of various maturities. Its benchmark is the JPM Global Government Bond Index (unhedged) and the fund focuses on the sovereign debt of the G10 group of nations, which includes the US, UK, Germany, Switzerland and Japan. But it can also invest in emerging market government debt (up to 20%). Morningstar analyst Louise Babin praises the “stable at experienced team” led by bond veteran Paul Brain, who has been managing the strategy since late 2008, and the fund’s solid track record. But she says the funds’ peers are able to invest in corporate bonds, whereas this fund does not, and that can leave the fund at a disadvantage when corporate bonds outperform government debt (as it has done in 2009, 2012 and so far this year).
Emerging Markets - Barings EM Sovereign Debt Fund - Silver
Moving up the risk scale, Barings Emerging Markets Sovereign Debt Fund has a Morningstar Analyst Rating of Silver for the fund’s cheaper share classes.
According to Morningstar fixed-income analyst Evangelia Gkeka, the fund “offers exposure to an experienced management and analyst team, has consistently applied its well-defined investment process, and has achieved attractive absolute and risk-adjusted returns since inception in 2015”. Lead manager Cem Karacadag is also praised for his long experience in emerging market bonds. This year the fund has posted returns of 7.48%, beating the benchmark, the JPM EMBI Global Diversified index and the Morningstar Global Emerging Markets Bond Category. Over five years the annualised gain is nearly 14% - in 2016 the fund returned a chunky 32% as holdings in Argentina, Ghana, Brazil and Jamaica outperformed.
Current top holdings include the debt of Brazilian state-owned oil company Petrobras, and government debt from countries such as Brazil, Mexico, Ukraine, Russia and Paraguay. The majority of the portfolio invests in local-currency government bonds – “the largest overweightings are in countries with strong and/or improving fundamentals, where according to the team, the market is overpricing fundamental default risk,” says Morningstar’s Gkeka. As the holding in Petrobas shows, the fund also invests in corporate bonds, where the returns are often higher, but the exposure to this asset class is usually limited to 10% of the portfolio. The current yield of the fund is 4.68%, much higher than developed world bond funds.
