The risk of chasing high-yield returns

Investors attracted by the great performance of bond funds in the last year should be on their guard. There has been no shortage of warnings about the potential for disappointing returns from low-risk corporate bonds over the coming months. But with asset managers trumpeting the potential of absolute return funds, investors can be forgiven for being confused.

Strategic and high yield bond funds are interesting because most companies have taken investor-friendly action over the past two years to cut costs and preserve profit margins. But there are a number of serial poor performers out there. The standout dog fund in the strategic sector is the Axa Sterling Strategic Bond fund run by Julie Lamirel, which would have lost £73 from an initial £1,000 investment over five years – and that is without adding capital erosion suffered as a result of inflation. The difference between the best fund in the sector over five years and Lamirel's fund is £508.

Lamirel, a senior manager of the fund, says that the underperformance has been the result of being overweight in financials during the economic downturn, particularly banks. Worse still, the fund then reduced its exposure to financials in the second half of 2008 and so didn't benefit from the uplift.

"When we went into the crisis we had the wrong positioning," Lamirel says. "We then reduced financials and if the crisis had been tougher, we would have been right – but the recovery was quicker. We still see the risk of another downturn, so don't want to take big bets."

Over 10 years, Axa can also be found at the bottom of the table, this time courtesy of its Framlington Managed Income Fund, managed by George Luckraft. Unlike the fund managed by Lamirel, however, Luckraft's performance has improved considerably over the past year, reaching the top 10 per cent in the sector over the past six months.

Axa escapes the dog fund list for the High Yield sector, but the track record of Gartmore's High Yield Corporate Bond fund is nothing short of woeful. As the worst fund in the sector over one year, three years, five years and 10 years, even the investment house has changed the management and structure of the fund. Gartmore's High Yield Corporate Bond fund could only manage growth of 17.5 per cent in the 12 months to the end of February, in a sector where the average growth rate was 40.6 per cent. Worse still, the fund was the only fund in its sector that isn't in positive territory over five years.

It is not surprising then that Gartmore switched to a new fund manager last July and rejigged the fund's investment objective in November.

There are better options for investors looking for strategic and high yield funds. For strategic investors, Invesco Perpetual's Monthly Income Plus was the best performer over 10 years. For those that can stomach slightly more risk and volatility, Baillie Gifford's High Yield Bond fund could be the answer. While its five-year return of £1,283 from £1,000 may seem modest, it is better than the sector's worst performer. But the fund had a stunning 12 months to the end of February, resulting in a 49.4 per cent return – only five funds did better.

This research is taken from the April edition of 'What Investment' magazine, in newsagents from Friday 26 March.