Global bond returns defy pessimists

26 October 2009 | By Brian Tora

When IFAs were pouring money into corporate bond funds, in a reaction to falling share prices and rock-bottom interest rates on bank deposits, I recall cries that this could prove to be the next mis-selling scandal. A bubble was expected by many as cash flowed into an asset class still little understood. The fear was that values would implode if the recession tightened its grip and company failures accelerated.

In August I reported on the state of the domestic corporate bond market. Returns over the previous six months had been more akin to those associated with equity funds, with the best-performing fund returning close to 30%. Two months on, it is the turn of the Global Bonds sector to go under the microscope. The returns are even better, with the top-performing fund rising by more than 50% over six months. Is this a bubble? Consider the background.

Experience suggests that private investors tend to pile into asset classes towards the end of a bull run. Perhaps the big difference between the corporate bond sector and a sector that attracted a serious inflow of private client money like, say, technology in early 2000, is that there was not a price surge in advance of the buying interest. Indeed, bonds were hammered almost as much as shares, as fears over the sustainability of the capitalist system grew in the aftermath of the collapse of Lehman Brothers .

The corollary of falling bond prices is that yields rise. With companies cutting dividends, sovereign debt returns falling as a consequence of the flight to quality and the interest on bank and building society deposits collapsing in the wake of monetary easing, the yields on corporate bonds became attractive. So the flow of money into these funds was less a “me-too” reaction - chasing an over-hyped asset class - than a desire to secure a high income when other options were failing to deliver.

All this applies to domestic bonds as well as global issuance. But it has been global bonds that have returned the most impressive performances. The reason is not hard to determine. Sterling has suffered in the difficult aftermath to the credit crunch. With financial services such an important component of the British economy, and with British government debt soaring as measures were introduced to stave off a deep recession, following a period of increased public spending, faith in the domestic currency crumbled.

The foreign exchange gains are expressed in the superior performance of funds focused on European bond markets. Over longer time-frames emerging markets start to feature strongly. In part this is a consequence of ratings agencies re-assessing their judgment of these markets. This is not a one-way street, though. These agencies are just as capable of pulling the rug from under issuers, so emerging market bonds are likely to remain at the more volatile end of what should be a more stable sector.

Turning to the winners and losers in the global bond stakes, there are surprisingly few specialist fixed interest fund managers among the market leaders. Perhaps the nearest to a boutique in this field is GLG, better known as a hedge fund manager. GLG’s performance has been consistent over the longer time-frames, although it has slipped to second quartile in the six-month tables.

Several investment houses offer a range of global bond funds. Both M&G and Threadneedle have no fewer than five. Performances can vary, though. Threadneedle has delivered the most consistent performance, although the newest fund - Global Bond - is stuck at the bottom of the six-month table. M&G’s International Sovereign Bond fund is the worst-performing fund over this shorter period, demonstrating the vulnerability of government paper to re-assessment, given the lower yields it offers.

The Investment Management Association says there are 52 funds in this sector, although only 47 have a track record of at least six months. The performance range is considerable. Twelve funds would have lost you money over the past six months, despite the top performer returning a rise of more than 50%. Even over five years the worst-performing fund did little better than break even - and this was focused on European bonds, which have risen sharply this year.

For investors and their advisers this is a sector that has moved into the mainstream. With many forecasters expecting sterling to continue to weaken, having a measure of currency protection appears no more than common sense. But the range of returns makes the task of selecting an appropriate fund particularly difficult. Moreover, sovereign debt funds do appear riskier, particularly if inflation re-emerges. As with domestic corporate bond funds, the easy money has been made, but global bonds deserve consideration for many investors.