Global bonds show vulnerable side

The global bonds sector continues to be a lynchpin for income-seeking investors but could be hit by the concerted global approach of shoring up economies with cheap money

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With economic growth muted around the world and signs that inflation is moderating, now could be an appropriate time to take a look at the Global Bond sector, last reviewed nearly two years ago. Back then the reverberations from the global financial crisis were still influencing investor behaviour. With inflation rising, but cash yielding next to nothing, bonds had performed surprisingly well. Even so, the one year tables saw average returns in negative territory, despite reinvested income.

Today, with inflation generally coming down around the world despite all the monetary easing that has taken place, and with interest rates still close to zero on both sides of the Atlantic, global bond funds are if anything finding the going tougher. Comparing the results achieved in September 2011 with those to the end of last July show that returns have been more muted. Given that the global economic scene is still far from clear, perhaps this should come as little surprise, but it is nonetheless disappointing.

All the signs are that interest rates are unlikely to start rising in a serious fashion until economic growth has been restored in a meaningful manner. Here in the UK the measure announced by new governor of the Bank of England Mark Carney is lower unemployment. Similarly, in the US it is clear that the earlier indications of a tapering of quantitative easing might be imminent turn out to be premature, with the Federal Reserve clearly more concerned that the tentative recovery needs to be seen as more robust before they act.

For bond markets it has been the economic slowdown and fears that some emerging nations might be suffering from the stresses of recent years that have driven a flight to quality. This has resulted in some relatively poor recent returns, while the longer term performance figures are benefitting from the improved conditions that have developed since the financial crisis brought about by the collapse of Lehman Brothers in the autumn of 2008.

Back then all asset classes went sharply into reverse as fears for the sustainability of the global financial system gripped investors. By 2011 markets were in recovery mode, so the leaders in the Global Corporate Bond sector were able to deliver returns of 80 per cent or more, with even the average fund more than a third up, including reinvested income. Today the results are even better, with the average fund up by 45 per cent, the top two more than doubling and several funds not too far behind.

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Contrast that with the six months figures, where capital values actually fell on average and even the best performing funds delivered only modest returns, after including income. Of more interest is that the leaders this time around are very different from those in the vanguard two years ago. Some groups make it into both sets of tables, but with different funds, while only the Principal Preferred Securities fund features then and now.

Of the funds in the current tables, the prize for the most consistent performer must go to Brookfield’s High Yield Europe Plus fund. Headquartered in New York, Brookfield is a boutique retail manager, but one that is part of a 100 year old established investment business with $175bn under management. They are not, though, a fixed income specialist. Rating, as their fund does, in the top five over all time frames reviewed, is an achievement in what has clearly become a more difficult sector in which to generate good returns.

The revolving door in terms of individual fund performance from groups with a track record in the fixed income arena makes selecting an appropriate fund that much more difficult. Take M&G as an example. Two years ago their International Sovereign Bond fund was gaining plaudits. Today they struggle in the second quartile for much of the time, dropping to a negative return over one year when they rank 99th out of 112 funds. What worked before may not hold good today.

The future for this sector is altogether harder to assess. Bonds continue to provide a lynchpin asset class for the income seeker, but remain vulnerable to any change in the concerted global approach of shoring up economic performance through cheap money. What may be happening, though, is the realisation that the great financial experiment that is quantitative easing will be hard to unwind, other than over a protracted period. A sudden shift to higher interest rates, with its concomitant effect on bond values, may not now occur. Choosing the right fund to cover this changing environment will not be easy, though.