Best bond funds

Bonds are one of the main pillars of the investing landscape. Viewed as a halfway house between the security of cash and riskier investments such as stocks and shares, bonds offer a rock-solid choice for those in search of a secure, fixed income.

Bonds were once regarded as a straightforward means of earning interest while preserving capital. Today’s bond markets, however, are complicated affairs worth a staggering £100 trillion worldwide, according to the Securities Industry and Financial Markets Association.

Bonds are not entirely risk-free. In the FAQs below, we discuss why, after years of benign conditions, today’s economic climate means bond investors are facing a tough time.

The main option for retail investors such as you and me to gain exposure to bonds is by investing in funds that specialise in this area.

We asked John Royden, head of research at wealth manager JM Finn, to identify five bond funds that are suitable for would-be investors with differing risk profiles.

His selections appear in alphabetical order, along with his justification for each choice, plus key details such as management charges.

Note that stock market investing involves risk and is not suitable for everyone. Before you consider investing, it’s important to work out your financial goals.

Ideally, build up a ‘rainy day’ cash fund equal to at least three months of your usual outgoings before taking the investment plunge. Note that the value of investments can fall as well as rise, and that all your capital is at risk.

Capital Group Global High Income Opportunities Fund

Fund type: SICAV

Fund size: £1.1 billion

Management fee: 0.75%

Key points:

• The fund’s aim, over the long term, is to provide a high level of total return. Total return represents all the gains made from an investment, including both price appreciation plus any income generated.
• A large component of the return is accounted for by income derived primarily from a combination of emerging market government bonds and corporate high-yield bonds from around the world (see FAQs below).
• Investing broadly enables an overarching approach to risk management and has historically provided a less volatile pattern of returns.
• The fund is able to harness the resources of Capital Group, allowing for extensive research across the higher-yielding universe of investments.
• The portfolio also has four managers providing a large degree of continuity.

Who should invest?

Investors who are looking for higher returns and who can also afford to take the greater risk associated with high yield /emerging market debt.

Capital Group US Corporate Bond Fund

Fund type: UCITS

Fund size: £78 million

Management fee: 0.5%

Key points:

• The fund’s aim, over the long term, is to provide a high level of total return consistent with capital preservation and prudent risk management. As above, total return refers to all the gains made from an investment, including price appreciation plus income.
• The fund invests predominantly in US dollar-denominated corporate bonds.
• At the beginning of August 2022, corporate bonds from the financial sector made up about a quarter (26%) of the portfolio, with utilities (14%) next.
• Government debt accounts for about 11% of the portfolio.
• The fund is run by managers Scott Sykes and Karen Choi who between them have 30 years of investing experience.

Who should invest?

Suitable for lower risk investors who want a steady income stream without taking too much risk. Ideal for investors in or approaching retirement.

CG Asset Management Dollar Fund

Fund type: ICVC

Fund size: £839 million

Management fee: 0.25%

Key points:

• The aim of the fund is to achieve long-term capital appreciation and income growth by investing mainly in US government and corporate index-linked bonds, particularly Treasury Inflation-Protected Securities (TIPS), which are similar to UK index-linked gilts.
• The fund may also invest in conventional government and corporate debt with the emphasis on investment-grade bonds where applicable.
• The fund is run by Peter Spiller, Alastair Lang and Chris Clothier. Spiller founded CG Asset Management in 2000 having formerly worked at investment firms Cazenove & Co and Capel Cure Myers.

Who should invest?

Investors looking for inflation protection from their bond allocation and a diversification away from sterling risk but who also want a relatively low risk of default.

CQS Global Sustainable Convertible Fund

Fund type: OEIC

Fund size: £230 million

Management fee: 0.65%

Key points:

• The investment objective of the fund is to achieve attractive risk-adjusted returns over the medium to long term primarily by buying and holding convertible securities across global markets (a convertible security is a hybrid form of investment possessing features akin to both bonds and equities).
• Convertibles usually exist as bonds or preference shares (securities with specific rights) which can then be converted into a different security, typically a company’s ordinary stock. In most cases, the holder of the convertible determines whether and when to convert.
• Performance-wise, convertibles have a high correlation with equities on the way up in rising markets but also provide downside protection when equity markets are falling.
• This portfolio aims to produce returns which broadly keep up with equities, but with lower associated volatility.

Who should invest?

Investors looking for equity-like returns but with greater downside protection.

Janus Henderson Strategic Bond Fund

Fund type: OEIC

Fund size: £3 billion

Management fee: 0.6%

Key points:

• The fund’s objective is to provide a return by investing in higher-yielding assets including high-yield, investment-grade and government bonds, preference shares and other bonds.
• The fund may also invest in equities.
• As a strategic bond fund, the portfolio has a broad investment mandate allowing the managers to move the portfolio relatively freely to suit current convictions.
• John Pattulo and Jenna Barnard have been running the portfolio for 14 years and 10 years, respectively.
• Holders of the fund should benefit from the active management skills of its managers.

Who should invest?

Investors looking for cost-effective, diversified exposure to a broad section of the credit markets.

Methodology

John Royden, head of research at wealth manager JM Finn, says the company’s approach to scrutinising and picking funds is driven by a combination of factors. Largely this includes looking at historical performance - while acknowledging this in itself is not necessarily a reliable guide to future returns - in addition to considering the skill and tenure of the fund manager in question.

Also important is how a fund manager’s view of the investment world is aligned with that of JM Finn’s. Mr Royden says: “In addition, we always insist on meeting managers to provide us with the opportunity to evaluate and fully understand their investment outlook and processes.”

Frequently Asked Questions (FAQs)

What is investing?

Investing is the process of using your money to generate a profitable return. Investing always comes with the risk of loss. But so, too, does leaving your money under the bed where inflation can eat away at the value of your cash over time.

If you’re saving for the future – five years away at the very minimum – investing in stock market-based securities such as bonds has the potential to produce greater rewards than cash on deposit and can also head off the corrosive effect of rising prices. At the time of writing, the latest figures show that consumer prices in the UK rose by 10.1% in the year to August 2022.

What are bonds?

Along with cash and stocks and shares, bonds make up one of the main ‘asset classes’ that are associated with investing.

Bonds are also referred to as ‘fixed-interest securities’. Essentially, bonds are IOUs issued by governments and companies looking to raise money that can also be traded on the stock market. In terms of risk, they sit between the relative safety of cash and racier securities such as stocks and shares.

The UK government issues bonds known as ‘gilts’, while their US government equivalents are called ‘Treasuries’. IOUs issued by businesses are called ‘corporate bonds’.

In each of these examples, the institution issuing the bond does so in exchange for a loan. Gilts and Treasuries are government debt, while corporate bonds are company debt.

The term of the loan may last as little as a few months or, in the case of government bonds, can extend for several decades. In exchange for their cash, bondholders typically receive an interest payment, while the outstanding loan is paid back when the bond matures.

How does a bond’s interest payment work?

The annual interest rate paid over the lifetime of a gilt is known as the ‘coupon’ and is expressed as a percentage of the face value of the bond. The coupon is also referred to as the ‘nominal yield’.

For example, a conventional UK gilt might be described as ‘3% Treasury stock 2030’. The ‘3%’ refers to the coupon rate, in other words, how much interest an investor would receive each year (usually paid in six-monthly instalments). ‘Treasury stock’ means that you’re lending to the government, while ‘2030’ refers to the bond’s redemption date. In other words, when bond holders receive back their original investment.

The size of the interest payment typically reflects the relative security of the IOU in question. The greater the coupon, the riskier the bond.

How are bonds rated?

Global independent ratings agencies, such as Standard & Poor’s, Moody’s and Fitch Ratings, provide credit risk ratings for both government-backed and corporate bonds. Credit risk shows how likely a borrower (a bond’s issuer) is to default on their obligations to repay a loan.

The rating ascribed to a particular security can be used to determine whether it is an investment or speculative opportunity. Top-rated securities begin with AAA (the highest), followed by AA and A and are regarded as ‘investment grade’ debt. Lower-rated securities (BB or lower) are more speculative.

It is generally accepted that AAA and AA rated securities have a default risk of less than 1%. The risk increases as ratings descend through the alphabet.

Why invest in bonds?

As an asset class, fixed income has traditionally been portrayed as the boring cousin to stocks and shares. Over the past year, however, this has been anything but the case with the bond markets suffering a severe jolt to the system thanks to the wider economic environment.

The main culprit has been rising inflation, coupled with central banks’ willingness to tackle rising prices by hiking interest rates. Inflation is the biggest threat to bonds because, as prices rise, they erode the value of the fixed income you receive from a government or corporate IOU.

Earlier this year, fund manager Schroders acknowledged that the past year had resulted in an “extraordinary time for bond markets”. But it added that there are three reasons why bonds have now become an attractive investment:

• attractive valuations offering appealing ‘total return’ potential.
• diversification as part of a broader investment portfolio.
• evidence that slower global growth will lead to some anticipated interest rate hikes not being realised.

What is an investment fund?

Investment funds allow you to diversify your money via a portfolio of assets - such as a basket of bonds - in which a fund invests.

Contributions are pooled from investors, with the proceeds managed by professionals according to certain investment guidelines (such as maximum limits on certain types of holding) and with each fund having a particular target. For example, to achieve long-term capital appreciation and income growth.

A bond fund is a version of an fund where fixed interest securities make up the majority of the assets held within the portfolio.

There are different types of fund, including: Open Ended Investment Company (OEIC); Investment Company with Variable Capital (ICVC), Société d’Investissement à Capital Variable (SICAV), etc.

Each name refers to the way a fund is put together and how it works from day to day. The overall idea of pooling money from the contributions of multiple investors holds true for each type.

How do I invest in bond funds?

There are several ways to start investing, including, opening an investment account, trading via a platform, choosing a robo-adviser, or delegating your investments to either a wealth manager or financial adviser. Find out more here about your investing options.

How much do bond funds cost?

The bond funds highlighted above include their management fee. This provides an indication of the fund’s annual running costs.

The management charge is made up of a fund manager’s fees, as well as administration, marketing and regulation costs. The idea is to produce a standardised method of comparing the costs of funds.

For example, a £1,000 investment in a fund with a management fee of 1% costs £10 per annum. Additional administrative/dealing charges may also apply depending on how the fund was bought – direct from the provider, say, or via an investing platform.

How do I invest tax efficiently?

Individual savings accounts (ISAs) are a form of financial wrapper that offer a tax-free way to save and invest. A stocks and share ISA is a tax-efficient product that allows you to gain exposure to the stock market.