Strategic bonds: The easy play for investors

Investors broadly like bonds because they solve three problems at once – they deliver an income; they traditionally offer diversification from equities; and they also have relative ease of access.

Today’s yields are materially higher than they were for most of the 2010s, so bond funds once again generate meaningful income without investors needing additional equity risk. This makes them a particularly attractive option for those at or approaching retirement.

Please remember that the value of investments will fluctuate and returns may be less than the amount originally invested. Tax treatment depends on your individual circumstances and tax rules can change. Chelsea does not offer advice and so if you are unsure of anything please contact an expert adviser.

There is an old adage that you should hold as many bonds as your age to ensure you strike the right balance between generating returns and lowering your risk profile as you get older. For example, a 55-year-old with one eye on retirement should allocate 55% of their portfolio to bond funds as they transition from earning to conserving it. However, this profile has changed as people live longer.

Many high-quality bonds now offer 4–6% yields, which gives investors decent income even if capital gains are modest.

However, choosing the right bond fund is no simple task, particularly in this uncertain economic environment. For many, there isn’t enough time in their day to navigate the complex nuances of bond markets. This explains the popularity of strategic bond funds. They can hand decision-making to an expert, with a flexible mandate to roam across bond markets, finding the best opportunities.

Why strategic bonds are attracting attention

Some fixed income certainties for investors have been upended in recent years: the ‘safe haven’ characteristics of US Treasuries, for example, or the relative risks of developed and emerging market government debt. Credit spreads are at historic lows. The need for a nuanced and targeted approach has never looked greater.

In short – flexibility matters because the backdrop is uncertain:

• Inflation is lower than the 2022 peak but still sticky.
• Central banks may cut rates at a slower pace than many previously anticipated.
• Fiscal deficits are keeping long-dated yields elevated.
• Geopolitical shocks are making inflation expectations volatile.

Strategic bonds can navigate all of this by shifting between government bonds, investment-grade credit, high yield, short duration, long duration, and inflation-linked debt. They can also manage interest rate risk and geographical exposure.

The importance of active management in this space

Strategic bonds often thrive on the active decision-making of their managers; however, selecting the right fund can be a challenge. There are now 87 funds to choose from in the IA Sterling Strategic Bond sector – but investors must be aware that the additional flexibility means these funds are anything but homogeneous. With the additional flexibility offered by strategic bonds comes additional risks, and funds can vary widely on their outlook on the quality of bonds to hold, the geographies they are held in, as well as the duration of their bonds.

The diversity of approaches was particularly exposed in 2022 – this was one of the worst years ever for global bonds because central banks raised interest rates aggressively to fight inflation. Bond prices move inversely to yields, so funds with long-duration bonds were hit hardest. Some managers kept long-duration positions, expecting inflation and rates to fall (to their detriment), while others cut duration aggressively or moved into short-dated bonds and cash.

There was also dispersion in credit positioning, with some owning more government bonds, especially long-dated gilts or index-linked bonds, which suffered severe declines. By contrast, others held more high-yield corporate bonds, floating-rate debt, or shorter-maturity securities, which proved more resilient. Some strategic bond funds were genuinely unconstrained and highly active, while others had persistent biases toward certain sectors or styles.

Dispersion of returns*

What about income?

The flexibility of strategic bonds also means the yields (income) they offer investors can differ significantly. This can be based on what the manager owns (types of bonds, duration, currencies), interest rate conditions, as well as how the income is distributed (monthly, quarterly etc). Some also focus on capital returns over income.

A cautious strategic bond fund focused on high-quality government debt might yield around 3–4%. A higher-risk fund holding more high-yield corporate bonds could yield 5-7% or more.

Four strategic bond funds to consider

Investing across the capital structure – M&G Optimal Income

Industry veteran Richard Woolnough starts by forming a macroeconomic view based on his outlook for growth, inflation and interest rates. A differentiating feature of the fund is its ability to invest across the capital structure, with the manager able to invest in senior debt, subordinated debt or even equity, depending on which offers the best value. The fund has returned 14.2% in the past five years – whilst also yielding 3.86%**.

Total return focus – Nomura Global Dynamic Bond

Managed by Dickie Hodges, the Nomura Global Dynamic Bond is a ‘go anywhere’ fund focused on absolute returns. It is a flexible approach and incorporates an analysis of the global economy and the sectors and investment themes that look most attractive, with fundamental analysis, to generate strong idiosyncratic ideas. The fund has returned 15% over the past five years**.

Monthly Income – Premier Miton Strategic Monthly Income Bond

The Premier Miton Strategic Monthly Income Bond fund aims to provide investors with a steady monthly income while minimising volatility and providing a better risk-adjusted income compared to both bond funds and equity income options. This fund is very active in nature and has had turnover between 300-500% in the past. The fund is benchmark agnostic and tends to have a lower duration than the market. The fund yields 5.38% and has returned 19.2% to investors in the past five years**.

Low volatility and short duration – Jupiter Monthly Income Bond

A portfolio that, in the manager’s own words, is “not too clever” by using a bottom-up approach to harvest spreads with relatively low volatility. Managed by Hilary Blandy, Jupiter Monthly Income Bond has returned 20.6% to investors, more than double the average fund in the IA Sterling Strategic Bond sector (9.4%) – it has also been one of the least volatile funds in the sector in recent years. It also yield 6.55%**.

It is the simplicity of the portfolio that we like. The fund invests in a blend of investment-grade and high-yield bonds, with a short-duration bias. It is primarily a bottom-up portfolio. Hilary believes that the mix of investment-grade and high-yield bonds, combined with short duration, reduces drawdowns and boosts risk-adjusted returns. The fund’s duration is typically between 2-4 years. The preference for short duration bonds is because returns can be forecasted with greater confidence.