Bond funds that won’t hit the buffers
Interest rate rises pose a threat to all bond investors, but some funds deliver a high level of income and are better placed to weather any hikes. When central banks raise interest rates, bonds yielding lower amounts become less attractive, causing their price to fall. Bond markets have been on an unprecedented multi-decade run, as interest rates have edged downwards for the past 30 years. Now, America has begun raising interest rates, and the Bank of England only narrowly voted in favour of keeping Bank Rate at 0.25pc in its last meeting.
This is worrying territory for bond investors, who have been able to rely on share-level returns with far less risk. The major risk when rates rise comes from bond “duration”. This is not the length of time a bond has until maturity, but a measure of how sensitive bonds are to changes in interest rates.
If a bond has a duration of three years, that means its capital value is expected to fall by 3pc for every 1pc increase in interest rates. The larger the duration, the greater the risk interest rates pose – so at present, many fund managers are focusing on shorter duration bonds.
To help protect against shocks investors should spread their money across different types of bond. Alex Dryden, at JP Morgan Asset Management, said investors should also spread across countries, as UK bond holders typically have around 50pc of their money in the UK. He suggested areas such as debt issued by emerging market countries could help to “cushion the blow of rising interest rates”.
However, Mr Dyden said the outlook for bond investors looks tricky: “Central banks injecting money was designed to boost asset prices today at the sacrifice of future returns. It would appear for bond investors that the time has come to pay the piper.”
Telegraph Money asked two fund picking experts for the funds that are best placed to withstand rate rises.
TwentyFour Dynamic Bond Yield: Charge:
5pc 0.78pc This fund is more than 50pc invested in Britain and America, with the rest spread around Europe. Around 11pc is invested in UK and US government debt, with 25pc in bank bonds, 13pc in European high-yield bonds and 13pc in insurance company bonds.
David Lewis, manager of the Jupiter Merlin multi-asset funds, said that this fund and the other TwentyFour fund below have a short two to three-year typical duration.
TwentyFour Global Unconstrained Bond Yield: Charge:
0.74pc This fund can invest in a wide range of bond types and regions, meaning the managers can move into areas less at risk from interest rates – it also has the ability to take “short” positions, betting against the market or specific bonds. Currently, it is 35pc invested in Europe, 32pc in the UK and 21pc in North America. Bank bonds are 24pc, bonds made up of mortgages and other such debt are 16pc, and government bonds are 15pc. There is also 7pc in emerging market debt.
Royal London Short Duration Credit Yield:
0.39pc More than 70pc of this fund’s bonds mature in less than five years, and it is around 80pc invested in the UK. Top holdings include the debt of top investment trusts, such as Edinburgh and Temple Bar, as well as the bonds of cigarette firm Imperial Brands and banking giant HSBC. Ryan Hughes, of AJ Bell, the fund shop, said: “The team, led by Paola Binns are highly experienced and the fund has a lower turnover than many.”
Rising interest rates are generally bad news for bond portfolios, but not for these, says James Connington
Hermes Multistrategy Credit Yield: Charge:
0.82pc Mr Lewis said this fund, which only launched in 2014, invests in highyield and high-quality bonds but keeps duration at two to three years.
It is 26pc invested in North America, 14pc in Western Europe, 12pc in the UK, and 12pc in Latin America. Top holdings include General Motors, Airbus, Volkswagen and Tesco bonds.
‘It would appear for most bond investors the moment of reckoning is near’
M&G Strategic Corporate Bond Yield: Charge:
0.66pc Mr Lewis said this fund has 90pc in investment grade bonds – requiring a top quality rating.
The duration is longer, at around six years, but he said that the higher quality provides a level of protection, and “means they have the potential to rise if shares fall”.
The £3.6bn fund is 44pc invested in the UK and 28pc in America. Top holdings include bonds from Microsoft, Bank of America and Lloyds.
General Motors, whose Chevrolet division manufactures cars that compete in Nascar, is one of the bonds to help weather rate