Within the world of fixed income, strategic bond funds are exciting. Not everyone will agree, but those with a penchant for the intricacies of bond investing will know where I’m coming from.
A key reason for this is that theoretically they are unconstrained, with managers enjoying great flexibility to move between the various corners of the fixed income asset class as opportunities present themselves.
However, for anyone who has allocated to funds within the sector, it soon becomes clear that not all strategic bond funds are created equal, and very few, in practice, are genuinely unconstrained. In fact, different cohorts of the sector are attempting to deliver entirely different outcomes in entirely different ways.
This, in and of itself, is no bad thing. Greater diversity equals greater choice. However, fund buyers must be sure footed in their selections.
Crucially, buyers must decide exactly what they’re looking for in a strategic bond fund. As this, by itself, could be an array of things: total return, outperformance of a specific index, low correlation to risk markets, high income, any combination of the four, or something else entirely. Once decided, selectors have a yardstick by which to go out and assess the competition accordingly.
Undertaking a review of the sector however can require a fair bit of digging, as many funds either do not state a benchmark or give the sector as their benchmark (unhelpfully sidestepping the issue of the variability of funds therein).
Having been disappointed by their desk work, the next step for fund buyers is to ask fund managers if there is an index/composite of indices that they look to outperform over time. If this aligns to the selector’s desired exposure profile, they can then assess the historical risk profile/allocations of the fund to ascertain whether it has provided a reasonable appropriation of the risk of their stated index. If this stacks up, and relative performance looks solid, they may just be onto a winner.
By way of an example, in the instance that a strategic bond fund is being used as part of a diversified multi-asset portfolio, a likely key feature of the fund will be to provide diversification from risk assets.
Investors should therefore be looking for a fund that is always within a few years of the duration of a core bond index, thereby excluding those funds that have been down at the lower end of the duration range (as many in the sector have been), or those that have oscillated wildly in their duration exposure (which few in the sector do).
Alternatively, when building an income portfolio, rather than diversifying the risks, allocators will likely want a fund that’ll boost the portfolio’s overall level of income. In this case, searching for funds with an income and risk profile akin to a credit index is likely preferable.
Whatever an allocator’s desired risk profile, once confident they’ve found a fund that meets this, with a good manager at the helm, they’re likely good to go. From there, allocators can happily monitor the fund’s exposures and performance versus the agreed target, whilst keeping an eye out for other funds with similar, or complementary, risk profiles to either challenge, or add, to the incumbent.
Some might say I’m missing the whole point of the sector here, that managers should be free to swing the exposure of their funds as they see fit, without being held accountable to any index. However, from my experience, very few funds in the sector are actually managed this way, and besides, why would investors want a fund with an entirely unpredictable risk profile anyway.
Paul Angell, head of investment research at AJ Bell. The views expressed above should not be taken as investment advice.