The news from the IMA that fixed income funds saw record redemptions in June does not surprise us. We have been warning for some months over the growing risks in fixed income and the absence of fundamental value across much of the market.
The culprit here is so-called “Quantitative Easing” which involves huge bond buying programmes by the US Fed and other central banks. This has severely distorted prices in large parts of the fixed income market, to the point where many bonds look expensive and offer yields that simply aren’t attractive once inflation is factored in.
In particular, developed market government bonds, index linked bonds and investment grade corporate bonds look vulnerable as and when the markets finally decide that “QE” will come to an end. Investors are therefore right to wake up to the fact that so-called “low risk” bonds will generate capital losses at some point.
In the current environment we favour strategic bond funds for fixed income exposure, though the focus of these will be overall return rather than income yields. These are funds where the managers have a high degree of flexibility to move across the bond universe and also the ability to shorten the average duration, which is a way of minimising volatility.
Funds we rate highly are Kames Strategic Bond, Legal & General Dynamic Bond, M&G Optimal Income and TwentyFour Dynamic Bond. These funds are generally running with quite short average durations of around 2 years.
We also think high yield bonds offer more attractive yields and should be less exposed to changes in interest rate expectations but will not be completely immune from any future turmoil. AXA Global High Income is our highest-rated fund, though we also like the AXA US Short Duration High Yield fund.