Bonds represent the debt of companies and other institutions and are generally less risky than shares. Bondholders just need a company to retain (or ideally improve) its creditworthiness rather than grow profits ahead of expectations. That’s why bonds can play an important role in a portfolio. Often, they behave differently to shares, so they provide diversification. They can also provide a decent, regular income for those who require it.
There are lots of options for investors wanting to include bonds in their portfolios. Some funds specialise in particular areas including corporate bonds, government bonds or riskier high yield debt. Others are generalists, offering a portfolio that spans a wide variety, with the manager aiming to capitalise on the best opportunities and to adapt to the changing market environment.
Funds in the Investment Association Sterling Strategic Bond sector generally aim to offer this ‘one stop shop’ for bonds, and they can represent a useful tool for investors. Choosing what sort of bond exposure you want can be complicated and requires some specialist knowledge, so investing in a portfolio run by experts offers a neat short cut. However, there are no guarantee the managers will get their tactics right.
One fund that has consistently impressed us in terms of the discipline and decisiveness displayed by the managers is Janus Henderson Strategic Bond Fund. John Pattullo and Jenna Barnard aim to add value by allocating between a range of bond areas dynamically over time and through intelligent individual bond selection. In our view, the flexibility of the fund combined with the depth of resource and experience of the managers affords the chance for good long-term performance.
This year, the managers moved decisively to take full advantage of changing market conditions. Having entered 2020 on a defensive footing with significant exposure to safer government bonds such as UK gilts and US Treasuries, the managers quickly shifted their stance in March as the severity of the global outbreak of Covid-19 became apparent. Ms Barnard described the changes made to the portfolio as “the biggest asset allocation shift in a decade for the team”.
The managers seized the opportunity to increase the fund’s exposure to corporate bonds during the exceptionally weak market conditions and benefited from the subsequent rebound through April and into the summer months. Corporate debt tends to yield more than government debt, and as a result the fund’s distribution yield moved up from around 1.5% to well over 3%. As well as buying individual ‘investment grade’ corporate bonds, deemed relatively safe, the managers moved quickly to tactically add exposure to riskier European high yield debt through a derivatives position.
Many of the individual bond positions added were not new to the team. In many cases they re-added names that had been sold in previous years on valuation grounds, taking advantage of some remarkable pricing for debt in companies the managers considered had solid prospects. They were also keen to avoid stressed areas where they believed the outlook had permanently deteriorated as a result of the pandemic such as leisure and traditional retail.
Outside these obvious problem areas, as well as the energy sector, especially in the US, the managers note the extraordinary response from authorities to inject money into the financial system has kept default rates very low. 2.5% in US high yield outside oil and retail and around 3% in Europe – typical Ms Barnard suggests of a ‘good’ year. She explains that companies have, on the whole, experienced a liquidity not a solvency problem, and unlike the 2008/09 global financial crisis the market was open for companies to obtain funding to ‘bridge’ a difficult 12 to 18 months. As such by avoiding a few acutely affected areas it has been a good environment for corporate bonds and an opportunity to lock in decent yields for the long term.
Since the chaos of March and April the managers have pared back their bias to corporate bonds while maintaining relatively low sensitivity to inflation, largely reflecting the lack of return available on longer dated government bonds. The managers have long believed that inflation is not a significant threat and stand ready to increase their government bond positions should yields rise modestly from here. These would benefit from a ‘lower for longer’ outlook for inflation, but they also point out that maintaining some exposure to safe government debt should continue to provide important diversification for investors.
For now, however, the managers are more positive on corporate bonds as markets have “moved on to a ‘post Covid’ world” of rapid recovery. They also suggest it is the right time to be in corporate bonds as, in general, quality companies continue to make their balance sheets more secure rather than taking on more debt, a friendly environment for bond investors. There will of course be losers as well as winners as the economy resets post-Covid, but they are adamant that, overall, big businesses are in good shape.
When assessing the role of a corporate bond fund in a portfolio it is important to consider what is required. If it is a steady income, then a traditional funds in the Investment Association Sterling Corporate Bond sector will likely be of interest. However, if it is to maximise overall returns from the asset class (growth and income), and to provide greater diversification from share markets, then a strategic bond fund may be a better option.
We believe this fund is genuinely ‘strategic’ rather than being permanently skewed to a market view, owing to the unconstrained, selective approach adopted by the managers. Investors benefit from the nimble decision making of a small team, supported by a very large and well-resourced credit research team. To us it remains a stand out in the sector and part of our Direct Investment Service Preferred List our curated list of investments for new investment in their respective sectors.
Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
Janus Henderson Strategic Bond – fund update
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