performance in the sector has been consistent, with the Average fund returning 22.04% over the three years to the end of march 2003, bid to bid
The Corporate Bond sector has been a relatively good place to invest over the past three years, with funds offering steady returns throughout the period.
The average portfolio returned 22.04% on a bid-to-bid basis over the three years to the end of March 2003. Only one fund, the Smith & Williams Fixed Interest portfolio, posted a negative return in any discrete one-year period, returning -2.72% for the year to the end of March 2002.
Funds that significantly underperformed often did so because of just one or two holdings in companies that defaulted. This was the case for Exeter Fixed Interest, which returned 16.82% over the three-year period, 5.22 percentage points below the sector average.
Fund manager Paul Craig said: 'Performance suffered from one company going bust. Atlantic Telecom defaulted and because it accounted for around 3% of the portfolio, it had a significant impact on the overall fund performance.'
This glitch caused the fund to return 1.78% for the year to the end of March 2002 against an average return of 4.54%.
Since Craig took over the fund around six months ago, he has been seeking to limit this type of risk by increasing the number of bonds held from the 30-40 it has typically had in the past. He said: 'I now have around 50 stocks in the fund and am looking to increase this to around 60 as good buying opportunities present themselves.'
Part of the reason the Exeter fund had a relatively concentrated portfolio is the nature of the fund house, according to Craig.
He said: 'We are a small company so we do not have huge resources to do a massive amount of research and take views on ratings on a large number of companies.'
This contrasts with the Fidelity MoneyBuilder fund, which has around 150 stocks. Manager Ian Spreadbury believes it is this diversification and the analytical resources upon which he is able to call that has led to the strong and steady performance of the fund.
He pointed to the 17 quant and credit analysts based in the UK and the 57 analysts based in the US, which he said enable him to get a comprehensive view on how the whole of the market is performing. This has made it less likely he will get caught in companies that get downgraded or default, he added.
The nature of the sector means the avoidance of negative outcomes for bonds is key, according to Spreadbury. He said: 'There is an asymmetric risk so that if everything goes well there is no great upside, but if anything goes wrong it can seriously affect your performance.'
With this in mind, the fund avoided the higher yield end of the spectrum last year when there were a lot of downgrades.
This fed through to its most significant outperformance of the sector, rising 11.19%, the second highest increase for the year to the end of March 2003, against a sector average gain of 7.76%.
The fund is the top performer in its sector over the three year period, with a return of 27.03% against the sector average of 22.04%, despite not being the top performer in any discrete year. Spreadbury puts this down to the way the fund aims to achieve returns.
He said: 'I aim to get consistent performance against the benchmark. Because of the diversification, we can take a large number of small bets and get steady but not spectacular returns.
'This means we may often be at the top of the second quartile over short periods but it will lead to top quartile performance over the longer term.'
This policy of not taking huge sector bets means the fund has tracked the index fairly closely. At 0.94, its R-squared is significantly higher than the average of 0.83. Despite this approach, the fund has a relatively high beta, at 1.06, compared to 0.96 for the sector average.
At 1.08, the high beta of the Aegon Extra Income fund can be traced more directly to the way it is run. It achieved its outperformance with a much more focused approach. The fund has around 30-40 holdings, which has led to periods of both underperformance and outperformance over the three year period, according to the fund's manager Stephen Snowden.
Despite this, the fund outperformed in each of the three discrete years to the end of March 2003 to varying degrees. This in turn led to an overall return of 25.7% against the sector average of 22.04% for the three-year period. Snowden highlighted one example of activity that negatively affected the performance of the fund. He said: 'In the third quarter of 2002, we were overweight more cyclically sensitive bonds at a time when they suffered. Companies like Credit Suisse, Ford and Bombardier were hit as they were exposed to the dip in the equity markets.'
This setback affected the fund's performance but it still returned slightly more than the sector average in the year to the end of March 2003, posting 7.79% against a mean of 7.76%.
Snowden believes the impact on performance would have been worse if he had made a snap decision to sell based on short-term negative movements rather a longer-term view.
'I think it is important not to be panicked out of positions,' he said. 'We stayed at the higher end of the yield curve, being heavily weighted in the A to BBB end of the market and with very little in AAA or sovereign debt. This paid off over the long term.'
These large positions have led the fund to record substantial differences in performance to the rest of the sector, shown by the relatively low R-squared of 0.78. The Exeter fund had an even lower R-square at 0.68, which Craig puts down to steering clear of certain sectors such as autos and telecoms and maintaining a low weighting in utilities.
By remaining out of such volatile areas, the fund was also able to maintain a low beta, at 0.71 against the sector average of 0.96.
The L&G Managed Income fund has also taken fairly large positions since it was transferred from Barclays in September 2001, according to associate director Robert Barnard-Smith.
The high weighting in AAA and AA bonds helped the fund in the immediate aftermath of 11 September, he said, but the subsequent move to higher yielding bonds has boosted performance since then. The move to a more active style of management has also aided the performance of the fund over the past two years, according to Barnard-Smith. It underperformed for the year to the end of March 2001 with a return of 7.62% against the sector average of 8.61%.
However, since L&G took over management of the fund it has outperformed, returning 9.57% against an average return of 7.76% for the year to the end of March 2003.
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