Funds bet on Australia and Canada to boost your income

INVESTMENT bosses have to take bigger risks in a bid to pay better rates to savers hunting for income.

Fund managers are taking bets on bonds from previously unloved countries such as Canada and Australia as they try to provide a steady return to investors.

Bonds are attracting masses of savers’ cash — trade body the Investment Association reported that £130 million flooded into these funds in February alone.

But their popularity is making these precarious investments ever more risky.

Bonds — which is the name for debt issued by a company or a government — used to be a byword for steady, stable funds.

Savers lend their money to the company or sovereign and are paid interest in return as well as getting their cash back after an agreed time.

Typically, these investments have been Steady Eddies which produced a reliable flow of income, particularly important for those in retirement who need to be more cautious with their cash.

Savers piled into them when the financial crisis hit in 2008, believing they would provide a safety net.

Investors flocked to the debt of blue- chip companies and large stable firms, as well as strong governments.

But this increase in demand and record low interest rates coupled with a raft of monetary policies by the Government and Bank of England meant the yields (essentially, the interest rates) paid by bonds plummeted.

Now, more than a quarter of all European government debt pays a negative interest rate. That means you are effectively signing up to lose money every year just by owning it.

Some 77 pc of German Bunds pay a negative yield, and even 26pc of Lithuanian sovereign debt pays a negative interest rate.

Phil Milburn, manager of the Kames Strategic Bond fund, says: ‘It may seem like the world’s gone mad, but I can understand the rationale of investing in negative yielding bonds though.

‘Sometimes it’s the least worst option — it would cost you money just to leave the cash in a bank account anyway because of inflation eroding its value.’

Strategic bond managers have the flexibility to invest in all types of bonds across the world — but even they are struggling to find decent opportunities.

Mr Milburn says: ‘ Everything looks overpriced, and that’s not just bonds, that’s equities too. For us, it’s about finding the bonds which win the least ugly contest, and that means more corporate debt than government debt.’

Certainly, until after the General Election, many managers are scaling down their investments in UK Gilts. Jon Mawby, manager of the GLG Strategic Bond fund, is looking at countries such as Australia and Canada instead, because they haven’t had bouts of monetary stimulus skewing valuations, as occurred in the UK, U.S. and Europe.

The U.S. is a major concern for investors at the moment because it is likely to be the first government that raises interest rates. This could mean a rollercoaster ride for bonds.

The price of a bond is determined by the interest payments investors can expect to receive. These payments look less attractive when interest rates rise.

Laith Khalaf, i nvestment analyst at Hargreaves Lansdown, says: ‘Consider a government bond that pays 2 pc annual income, or £2 per £100 invested. With interest rates at 0.5 pc, that looks OK, but if the Bank of England increases base rate to 4.5 pc, that wouldn’t look attractive at all and the price of the bond would fall as investors sold out.’

Of course, this is an extreme example. Interest rate rises are likely to be gradual, so any price falls would be gradual, too.

And while that theory provides bond optimists with comfort, others are concerned that after six years of rock bottom rates even a minor increase could cause panic in the market. Rumours of a rate hike in the U.S. in 2013 sent the market into turmoil for a short while.

And it is still unclear when rate rises will be — poor economic data from the U.S. suggest the Fed may not start making rate rises until the end of this year, while the UK is now thought to be unli kel y to move before early 2016.

To counter this, many managers are investing only in so-called short-dated bonds, which ties up money for just a few years, ra t her t han t en- y ear bonds t hat have hi s t ori call y been popular because of the stability they provide.

But Juliet Schooling Latter, at fund-rating agency Fund Calibre, says: ‘ I’m not convinced that we should be so relaxed about fixed income. A wall of money has gone into income-producing assets as people have been forced into riskier investments and, as demand has increased, yields have fallen.

‘You still need bonds to provide some diversification i n your i nvestments, but we are in uncharted waters and have no idea what will happen when central banks start to raise interest rates.’

She l i kes the Premier Asset Monthly I ncome f und, which currently yields 4.8 pc. It invests in other funds, which have money in company and government debt and property, and has turned £1,000 into £1,127 over the past year.

Take note — this is an expensive fund, costing 2.28 pc a year.

She also likes the Fidelity Money-Builder Balanced f und, which invests directly into a mixture of government and company debt.

Its biggest investments include UK Gilts and the debt of big UK blue- chip firms such as HSBC, Glaxo-Smith-Kline and Imperial Tobacco. It yields 3.5 pc and has turned £1,000 into £1,142 over the past year. It charges 1.2 pc a year.