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Investing isn’t easy. After all, most fund managers fail to beat the market after factoring in their charges. Bond investing, if anything, is harder still, with a raft of jargon from linkers through hard and soft currencies to esoteric instruments such as “cocos”. So, it’s no surprise that even professional wealth managers running client portfolios of funds will sometimes outsource the bond portion of the portfolio to someone else who will do the entire bond mix for them. That “someone else” is often the strategic bond manager and their services are available to the retail investor and are grouped in the Sterling Strategic Bond sector.

Unlike more restricted bond sectors, “Strat Bond”, as it’s known, can go anywhere, unconstrained by region, duration, or credit quality. This allows the active manager to go where they feel the best opportunities lie and avoid those areas of the bond market they reckon are best avoided—they can invest in everything from UK gilts through to emerging market debt.

It’s easy to understand why even professionals may wish to drop this can of worms into someone else’s lap, as the dynamics driving this asset class have been even more mixed than this abysmal metaphor. Bond returns are sensitive to rates: the longer the duration of a bond—or, in aggregate, bond fund—the more its value will fall as base rates rise, and rise as base rates fall. So, it’s easy to see why the current environment is greying those remaining hairs that bond managers haven’t already pulled out.

In 2022, rising rates drove a coach and horses through the fixed income market. Returns were strongly negative. Despite the investment industry trumpeting that “bonds were back” last year, returns certainly weren’t, as bond investors struggled to make it into positive territory. Over 12 months, the IA UK Gilt sector—the “baseline” for sterling fixed income fund investors—lost 1.68%, and over three years those losses spiralled to 24.78%.

For this year… who knows? Rate expectations carom hither and yon with each passing inflation report. One week, it’s “higher for longer”; the next, central banks are on the cusp of cutting… and back again. Small wonder that the many portfolio managers don’t want to tiptoe through this minefield.

Has Strat Bond’s flexibility rewarded those who’ve put their faith and cash into it? For Strat Bond, those figures are 3.99% and -3.01%. On average, then, the answer is “yes”. However, as ever, is all depends on the fund you select, as three-year returns varied between 12.35% and -29.33%.

Over 12 months to the end of January 2023, the sector suffered outflows of more than £8bn. As I mooted last time, if bonds are coming back into vogue, it could be a significant beneficiary. And the tide has indeed turned, with inflows to Strat Bond funds of £1.4bn over the past year.

Since last we looked at the sector 12 months ago, three funds have retained their place in the table below: BNY Mellon Inflation-Linked Corp Bond, PIMCO GIS Income, and M&G UK Inflation Linked Corporate Bond. Because of their lengthy duration, UK inflation-linked gilts took a real pounding, losing more than their plain vanilla equivalents, so the BNY linker fund’s presence at the top of the table is quite remarkable: that and the fact that it only lost 6.22% on 2022. It is, as you’d expect, running a shorter duration and is more globally diversified than the UK inflation-linked sector. It’s certainly a different take on “strategic”, given its inflation-linked mandate. The PIMCO fund, too, has likely benefited from its mandate to an average portfolio duration of zero to eight years, something that will have helped navigate it through the turbulent past couple of years.

However, the uncertainties around future rate trajectories may mean that future outperformers look very different from those of the recent past. That said, these same uncertainties will likely drive more money to this, until recently, out-of-favour corner of the market.

Table 1: Top-Performing Sterling Strategic Bond Over Three Years (with a minimum five-year history)

(Click on image to enlarge)

All data as of February 31, 2024; Calculations in GBP

Source: LSEG Lipper

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