When you invest in shares or equity funds it’s all about the future – the new products or services being launched, how the company will grow and profits increase. It’s exciting. But when you invest in bonds you are looking for the opposite – a boring steady investment that will pay you a steady income and not give you any nasty surprises.
Bonds can be an important component of an investment portfolio. But what do you need to know about them and how can you choose the best bond funds to invest in?
What Is a Bond?
In simple terms, a bond is a loan. Just as you or I would go to a bank to get a loan to buy a car or a mortgage to buy a house, a company may need a loan to buy new machines and a government might need more money for its health services or schools.
Only instead of going to a bank for a loan, companies and governments will ask investors to lend them the money instead. And, in return for lending them the money, the company or government will pay investors a certain level of income on a regular basis until it is time to repay the loan.
What Are Corporate Bonds?
Corporate bonds, as the name suggests, are issued by companies. Some corporate bonds are secured. These are the least risky, because if a company goes bust, anyone owning these bonds has first dibs on any money the company has left on its books to pay these bonds back. For example, if it was a bond from Tesco, it could be secured against a Tesco supermarket building.
Some are unsecured – which means there’s no building to sell to pay back money should things go pear-shaped – and some are convertible, which means the holder has the right to exchange their bond for shares of the issuing company if certain targets are reached.
While there are usually one or two different types of shares issued by a company, any one firm – particularly big ones – could potentially issue tens of bonds, with different maturity dates, different yields (levels of income) and different currencies.
What Are Government Bonds?
Government bonds explicitly invest in bonds issued by governments. You may hear them referred to as ‘sovereign debt’, ‘Gilts’ (UK) or ‘US Treasuries’. Since these loans are backed by governments, those in developed markets are considered less risky while those in emerging markets carry a higher risk. Again, any one government can issue many different bonds.
All Sound a Bit Complicated?
Strategic bond funds are the most flexible type of bond fund. They can invest in any type of bond – government, corporate and emerging market. So, if you can’t decide which type of bond to invest in, why not opt for a strategic bond fund and let a professional manager make the choices for you?
Is Now a Good Time to Invest in a Strategic Bond Fund?
Bonds were not that attractive after the global financial crisis of 2008 because interest rates around the world hit rock bottom. When interest rates fall, bond yields also fall, and prices rise. So, bonds became very expensive and didn’t really pay an attractive income.
2022 was therefore a difficult year for bonds. As interest rates rose the yields rose so the level of income they paid became more attractive, but their prices fell, and investors lost capital.
But with interest rates likely to peak in 2023/2024, bonds have become attractive again. Yields are much higher – about 5 or 6% in some cases – and, as and when interest rates start to fall again, the price of bonds will rise, and capital gains can potentially be made. And savvy investors have recognised this, with inflows into bond funds increasing in 2023.
With opportunities abound, here are a few strategic bond funds to consider.
Baillie Gifford Strategic Bond
Baillie Gifford Strategic Bond gives investors access to a concentrated portfolio of primarily UK fixed income securities, from both the investment grade and high yield segments of the market. The managers aim to add value almost exclusively through their stock-picking prowess and do not aggressively manage the interest rate exposure.
Jupiter Strategic Bond
Jupiter Strategic Bond is a flexible ‘go-anywhere’ fund that allows the manager considerable freedom to exploit opportunities across global bond markets. The aim is to achieve a moderate income. The manager is quite cautious in his approach and emphasises limiting potential losses in tough markets.
M&G Optimal Income
M&G is perhaps the biggest name in the UK bond space, and M&G Optimal Income is its flagship offering. This ‘go-anywhere’ fund has a flexible mandate, which enables the manager to shift the interest rate exposure and to invest across the fixed income spectrum. The fund can, and often does, invest in some equities, and also derivatives.
Nomura Global Dynamic Bond
Nomura Global Dynamic is an unconstrained strategic bond fund, with a focus on total returns. Its manager blends two approaches when building his portfolio. First, he studies the state of the global economy and identifies which sectors and investment themes look most attractive. He then undertakes fundamental analysis, to populate his preferred areas with ideas.
