Why we have been happy to avoid bond funds

Saltydog Investor points out that bond fund performance can be more volatile than investors expect. 

When I think about investing, I usually think of equities (shares), and the many funds that invest in them. However, the global bond market is larger, and the trading volumes are much higher. There are also lots of funds that invest in bonds, and the funds in the ‘Mixed Investment’ sectors can invest in both bonds and equities.

There are various different types of bonds. Government bonds are, as the name suggests, issued by governments. In the UK, they are called gilts and in America they are known as treasuries.

Then there are bonds issued by companies. The main risk to the bond holder is that the institution issuing the bond is unable to make the interest payments or pay capital back in full when it becomes due.

The Investment Association (IA) has always had separate sectors for different types of UK bonds. These are: 

• UK Gilts
• UK Index Linked Gilts
• Sterling Corporate Bonds
• Sterling Strategic Bonds
• Sterling High Yield Bonds

Anything overseas was just classified as a ‘global’ bond.

At the end of 2013, the IA introduced the Global Emerging Market (GEM) bond sector, and at the beginning of last year they split it into GEM – Hard Currency, GEM – Local Currency, and GEM – Blended.

Last month, the IA introduced more than 500 exchange-traded funds (ETFs) into its fund sectors. A significant number of these were going to end up in the Global Bonds sector and so they decided to break it down into 14 new bond sectors. They have been created based on the following criteria: type of bond, credit type and currency focus.

They have now separated UK, US, European, Global and GEM bonds, and each of these categories have different sectors for government bonds, high-yield bonds, corporate bonds, etc.

Here is a table showing all the different bond sectors, and how the funds in them have performed in recent years.

Although bond funds are often thought of as relatively safe investments, the prices can be surprisingly volatile.

In 2016, most sectors made double-digit gains and the best, USD High Yield Bond, went up by 36.4%. The following year it made a loss.

This year has not been great for the bond sectors. At the end of April, only three sectors were ahead of where they were at the beginning of the year. As momentum investors this is a trend that we have been happy to avoid. However, we will keep monitoring the performance of these sectors so we can take advantage when the tide turns.

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