Mark Dampier: By Jupiter, this strategic bond fund is flexible enough to pay off

 

The one asset class investors have worried about most over the past year or two is bonds.

Yet, as I write, equities have stumbled. Tensions between Russia and Ukraine along with worries about stretched valuations for technology and biotechnology shares have hit the whole market.

Bonds have been remarkably stable though, despite constant cries of a "bubble" in the past two-to-three years. But investors should not be complacent. With interest rates at 300-year lows you do not have to be Einstein to know the next move will be upwards. Higher interest rates make the fixed income offered by bonds less attractive relative to rates available on cash, so when interest rates rise bond prices fall.

Rising interest rates are also painful for those with high debt as the cost of borrowing rises. Given the enormous amount of private and public debt, I find it hard to believe interest rates will go up very far, perhaps hitting 2-3 per cent at most; although even this could cause turbulence in bond markets.

Nevertheless, Ariel Bezalel, manager of the Jupiter Strategic Bond Fund, remains relatively sanguine. Even after an exceptional run of performance he believes European high-yield bonds look attractive. In a world of low interest rates, low inflation and a respectable economic recovery he does not see any catalysts for the market to reverse.

Mr Bezalel is not complacent however. The strong performance has driven yields down (and prices up). The main European high-yield bond index now offers just 3.67 per cent. He sees little scope for this to fall much further and notes power is shifting to the borrower. By this he means companies looking to borrow money now include less protection for those who lend to them – effectively leaving the bond holders with higher risk.

Around two-thirds of the portfolio is invested in high-yield bonds, which includes 25 per cent in subordinated bank debt. These bonds rank lower in the pecking order if a bank defaults on its debt. They are therefore higher risk, but tend to offer a higher yield to compensate.

Approximately 15 per cent is invested in bonds issued by UK banks, split roughly 7 per cent in Lloyds, 4 per cent in RBS and 3 per cent in Barclays. A further 20 per cent of the portfolio is invested in floating-rate notes issued by similar companies – in effect, these are similar to high-yield bonds but the interest they pay rises (or falls) with movements in interest rates.

The remainder of the portfolio is invested mostly in bonds secured against specific assets, such as property or oil rigs. These bonds can offer attractive yields, but in the event of default the holders have a claim over the assets, which they could sell to recover losses.

Mr Bezalel has taken some profits from bonds that have performed well and the fund's cash holding has risen to around 7 per cent. The fund's "duration" (sensitivity to interest-rate rises) is down to 1.8 compared with 7.5 for the Markit iBoxx Sterling Corporates index. This means the fund's overall performance should not be affected heavily by a rise in interest rates.

For investors who still want exposure to bonds I think this fund is one to consider. It currently offers a yield just under 5 per cent and Mr Bezalel believes his strategy could offer some protection and be less volatile than others when interest rates rise. However, if he is wrong the opposite could be the case, so investors are placing their faith in the manager to make the right calls.

I do not believe the bond story is over, but it is important to focus on flexible funds run by experienced managers and I rate Mr Bezalel highly.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

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