All but four of the 39 funds that have been in the sector for three years to the end of August have posted positive returns over the period
Global bond funds have been a good place to be over the past three years, posting modest but relatively steady returns while their neighbours in the equity camp watched the value of their investments slide.
Global bond funds are classified as those that invest at least 80% of their assets in fixed-interest stocks, regardless of geographic spread, unless it is more than 80% invested in the UK, in which case it would be classed as a UK fund.
All but four of the 39 funds that have been in the sector for the three years to the end of August have posted positive returns over the period. On average, the sector has booked a return of 13.85% over the past three years on a bid-to-bid basis.
A lack of monetary elbow room and some corporate credit horrors have reduced returns in the past year, with an average gain of just 0.92% over the 12 months to the end of August, while 15 of the 50 funds in the sector recorded a loss.
But the previous two years were solid cases for the sector, which returned an average 4.69% over the 12 months to 31 August 2001, while equity markets suffered. Over the 12 months to 31 August 2000, the sector returned 5.11%. Just 8 of 48 and 4 of 39 funds made losses over the respective periods.
The £43.1m Invesco Perpetual Global Bond has been the third top performer in the sector over the three years to 31 August, posting a return of 25.49% for the period, almost double the sector average.
The fund's beta is 1.2, well above the sector average of 0.96, and reflecting what fund co-manager Paul Causer described as an 'extremely active' approach to the fund's management.
In the 12 months to 31 August 2000, the fund returned 10.29%, more than double the sector average of 5.11%.
Causer said the outperformance that year was due to long dollar and long duration positions, as well as being overweight on credit while the spread between corporates and government debt tightened.
Bond fund managers can take advantage of expected moves in interest rates by adjusting the average duration of securities in their portfolio.
The longer a bond's maturity, the more sensitive it is to a change in interest rates, so those expecting interest rates to fall will load up on longer-dated stock. When interest rates are expected to rise, managers will cut the duration of their portfolios. The following year, Invesco Perpetual Global Bond returned 11.27%, bettering its outperformance of the sector, which returned an average of 4.69%. Causer said a key factor in the year's gains was avoiding large exposures to the euro, which lost as much as 12% of its value against the dollar during the year.
'The year to 31 August 2001 was good for bonds but you could have lost it all by being in the wrong currency,' Causer said.
The past 12 months started well, with the portfolio long on US duration after the September terrorist attacks and the US Treasury announcing it would cease issuing 30-year bonds, leading to a rush of demand for the long-dated paper.
'That was the most fantastic rally,' Causer said. 'We benefitted from that and then cut the duration back.'
But the rest of the year has been difficult, with the portfolio over-exposed to the credit market, although returns for the past 12 months are 2.26%, still above the sector average of 0.92%.
'We are now trying to position the fund because we think the credit cycle is troughing out a little,' he said. The £136m Threadneedle Global Bond fund has had steadier performance over the past three years, during which it returned 17.59%, above the sector average of 13.85%, with a beta of 0.96, in line with the sector average.
Fund manager Sandra Holdsworth said the fund can invest up to 30% in emerging market debt or sub-investment grade corporate credit, so asset allocation is particularly important.
'In the first year, we were very close to the median,' she said. 'We didn't have any major plays against the competition in terms of currency or assets.'
This cautious approach was rewarded with underperformance in the 12 months to the end of August 2000, when the fund returned 4.81% against a sector average of 5.11%.
Holdsworth puts the result down to the fund's allocation in sub-investment grade, high-yield bonds. When the dot.com bubble burst in March 2000, high-yield paper started to underperform as many issuers were telecoms tied up in the technology boom.
The second year saw the fund return 7.53%, ahead of the sector's 4.69%, as Holdsworth steered away from exposure to the weakening yen. However, holdings in poorly performing emerging markets and high-yield bonds detracted slightly from the performance.
In the past 12 months, the fund has outperformed to the tune of 4.34% against a sector average of 0.92%, demonstrating relative steady returns. Late in 2001, Holdsworth positioned the portfolio to take advantage of official US rate cuts.
'In autumn 2001, when monetary policy started easing again in the US, this was very good for emerging market debt and was perceived to be very good for corporate debt,' she said. 'So from that point, we added to those two asset classes all through the fourth quarter.'
US rate cuts tend to drag global interest rates lower while simultaneously inflating the global economy, which is a positive for emerging markets.
'But this year, we have been reducing that element again because, although rates have been cut, the economy hasn't really got going yet to the extent markets were expecting,' she added.
Another steady performer is the £29.5m Friends Provident International Bond fund, which returned 17.59% over the three years to the end of August on an above average beta of 1.03.
In the year to 31 August 2000, the fund returned 4.54%, below the sector average of 5.11%.
Manager Richard Stevens said the fund was 100% invested in government paper during that first year, meaning it would have missed out on the tightening spreads between corporate credit and gilts.
However, an above-average duration position meant the portfolio didn't stray too far on the downside. 'US long-dated Treasury yields peaked in January 2000 and we had a sizeable allocation to 30-year Treasuries when the US government came out and announced it was projecting ongoing budget surpluses and everyone thought there was going to be a shortage of Treasuries,' Stevens said.
The following year, the fund returned 7.33%, outperforming the sector average of 4.69% by loading up on long-dated US Treasuries at the expense of European bonds as the US slowdown took hold.
'The economy was slowing down, the market expected the Fed to cut rates, so people were locking into the current yields that were available in advance of the cuts in official interest rates,' Stevens said.
Over the 12 months to 31 August, the fund returned 4.8%, well ahead of the sector average of 0.92% as an underweight position in poorly-performing corporate bonds paid off.
However, Stevens is now looking to ramp his credit allocation as government bonds appear fully priced.
'With 10-year Treasuries below 4%, they are getting close to discounting a deflationary-type scenario,' he said.
'The markets are anticipating that economic growth is going to stay soft for some time and inflation is going to come down.
'But that scenario is close to being completely priced in, so our strategy is to start becoming more defensive towards government bonds by reducing the duration of the portfolio slightly and overweighting markets in which there is more value, such as Canadian government bonds. We are also looking to increase the allocation to corporate bonds.'
The £23.6m Gartmore Global Bond fund has returned 12.28% over the past three years, although the performance has been uneven, with two years of above-average returns followed by a sharp fall into underperformance over the past 12 months.
The fund, which has a beta of 1.08, produced a return of 6.8% in the 12 months to 31 August 2000, with heavy positioning in US Treasuries. This was followed up with return of 6.56% over the 12 months to August 2001.
Performance fell in a hole the following year, with the fund returning -1.34%.
Manager Robert Jolly said the main negative contributor to the recent underperformance was a decision to diversify away from government bonds and into credit.
'We felt credit was cheap enough for the risks associated with subdued economic growth but, unfortunately, we invested in WorldCom, which caused us a significant amount of pain,' he said. 'That's why performance hasn't been great in the past four or five months.'
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