Bonds can prove to be perfect vehicle for the cautious investor
IF YOU fancy receiving a regular fixed income on your savings, consider the world of bonds. They are simply loans issued by companies or official bodies which wish to raise finance to run their operations.
Almost all bonds pay interest at a fixed rate from the start. It does not alter over the loan period and hence bonds are referred to as ‘fixed interest’ securities. The saver knows precisely what money to expect.
The capital is repaid when the loan matures and this date is set from the beginning.
Bond funds are particularly suited to more cautious savers, notably near to or in retirement, as well as those who like some protection in the event of a falling stock market. In the event of a failure or two, a collective is of course always a better safeguard.
Apart from defaulting on either the interest or repayment, there are other risks. Interest rates could rise faster than expected, inflation increase further or central banks could start to reduce the financial support provided to their economies.
Building societies are normally regarded as trustworthy but savers in two – Manchester and West Bromwich – had a shock when each defaulted on paying interest on their permanent interest-bearing shares, known as PIBs. In Manchester’s case, its Spanish loan book caused difficulties and from 2016 it has not paid the expected eight and 6.75 per cent respectively on two securities.
Look at both the capitalisation and payment history before lending. The strength of the UK Government in ‘guaranteeing’ its loans means that it can raise money without paying high interest. The distortive effects of quantitative easing and global low interest rates have meant conventional government bond yields have been kept at artificially low levels for some time.
The benchmark 10-year Government bond yield hit an all-time low of 0.52 per cent in August 2016 following the EU referendum and a further round of Bank of England lending. The yield has now improved to 1.25 per cent.
Its popular consumer arm is NS&I. If a fixed monthly income is required, its Guaranteed Income Bonds are available from £500-1m which pay 1.46 per cent for one year and 2.17 per cent for two years, both on an AER basis. Higher interest of 2.20 per cent is paid on its threeyear Growth Bonds. There are many Government loans issued which can be accessed through a stockbroker.
Among banks and building societies, some of the best rates are offered by lesser known names, such as Access Bank, Investec Bank and Paragon Bank. Starting with 1.8 per cent for a one-year loan, expect to receive 0.20-0.25 per cent extra for each year the money is tied up.
Yet such rates mean that your money will lose its value since inflation, as measured by the Retail Prices Index, is running at 3.9 per cent.
There is a wide range of bond funds in terms of:
Amount of freedom given to fund manager Types of bonds invested Geographical restriction for investments Number of individual holdings Term (or duration). Elizabeth Hastings, chartered financial planner at Chase de Vere in Leeds, says “investors should try to hold a range of different types of bonds. If investing in fixed interest to provide security, it makes no sense to rely on just one type of corporate or government bond.”
Diversification can be achieved by saving through several specialist bond funds or selecting ones with a broad investment remit.
‘Strategic’ bond funds mean the manager has the flexibility to invest across the bond spectrum and thereby secure opportunities. There is no restriction to one category, such as high yield, or one country. Hastings recommends Janus Henderson Strategic Bond, Jupiter Strategic Bond and Fidelity Strategic Bond.
Private client broker Hargreaves Lansdown picks two funds to consider: Invesco Perpetual Tactical Bond and Artemis Strategic Bond. However, their senior analyst, Laith Khalaf, cautions that “bonds are not the best place to be when interest rates are rising as they seem to be at the moment”.
Peter Sleep, investment manager at Seven Investment Management (71M), says: “It is very hard to find an active manager who consistently outperforms in areas like government bonds, so investors might like to select a passive fund.” Sleep suggests high grade developed government global bonds should form “a key component of most portfolios despite their low yields”. This is because when equity markets fall, high grade bonds generally rise and act as a cushion for a portfolio.
71M say that whilst most corporate and government bonds are currently fully valued, it sees value in the high yield and emerging market debt sectors. It tips Legal & General Emerging Market Bond fund and Robeco Quant High Yield, up 15.2 and 12.9 per cent on an annual basis respectively. The 71M AAP Balanced Fund includes both.
Floating rate bonds offer returns tied to movements in LIBOR, which itself tracks central bank base rates. Consequently, income returns can potentially increase as and when interest rates rise to a meaningful degree. The capital value of such bonds does not usually rise or fall to respond to interest rate movements unlike conventional bonds.
“This is quite an attractive proposition at the current stage of the cycle,” says Martin Payne, Leeds-based director of wealth manager Brewin Dolphin.
He favours both M&G Global Floating Rate High Yield fund and NB Global Floating Rate Income. Their annual income yields are around 3.8 and 3.5 per cent respectively. Floating notes are also tipped by John Royden, head of research at broker JM Finn.
Asset-backed securities have similar characteristics. Payne tips the high experience in this area of Twenty Four Asset Management and favours its Dynamic Bond fund, currently yielding 4.4 per cent, or for pure asset-backed exposure, the Twenty Four Income fund, returning an attractive 5.8 per cent yield.
For investors looking for general exposure to bonds – both government and corporate – Jupiter’s Strategic Bond fund is suggested by Payne.
Yielding 3.4 per cent, this collective aims to achieve high income with the prospect of capital growth and is unrestrained in terms of fixed income security or country.
Government bond yields started to spike sharply this month, prompting US fund manager Bill Gross of Janus Henderson to pronounce a bear market after a quarter of a century bull run. The jump was caused by speculation that China is slowing or halting in the US and Japan’s cutting support for longer-dated bonds.
Jason Hollands, of Tilney, thinks equities still have the edge over bonds but suggests cautious savers opt for a targeted absolute return fund which uses a wide basket of investment tools to deliver positive returns. He tips Aviva Investors Multi-Strategy Targeted Income 2 and Invesco Perpetual Global Target Income.
If seeking global corporate bonds, Adrian Lowcock of Architas likes Kames Investment Grade Bond which is not large and allows its manager to be flexible and responsive. For a passive approach, he selects iShares UK Gilts All Stocks Tracker which costs only 0.11 per cent.