The Best Bond Funds To Take Advantage Of Peak Rate Expectations

Last week’s surprise 50 basis points increase in interest rates has led to a flurry of speculation about how high the Bank of England will have to go to bring inflation under control. The last time they were five percent was 15 years ago before the global financial crisis, with the peak expected to be around six percent sometime next year.

Ryan Hughes, head of active portfolios at AJ Bell, says that the latest increase in rates indicates that the central bank is worried that inflation may be taking root in the economy.

“The accompanying statement indicated they are prepared to go further if there is ‘evidence of more persistent pressures’ and it does seem likely that they will raise again next month given that it will take some time for inflation to materially reduce from its current elevated level.”

Time For Bonds?

The increase has had an impact on many parts of the market, including bonds, where the 10 year gilt yield has risen to 4.30%, the highest it has been since the ill-fated Truss administration. This suggests that it could be a good time to cautiously think about topping up your fixed income exposure.

Bonds have been struggling for some time with the level of uncertainty causing particular pain. Investors can generally cope with the fact that rates need to go up, but not knowing the speed or when they are likely to stop is very unsettling for prices and yields.

Hughes says that it is important to remember that markets are forward looking and the immediate news is priced in.

“Investors are now thinking about where and when rates will peak and this may well present some opportunities to lock in some attractive yields, if there is comfort that the Bank of England and other central banks have got a grip on the problem.”

He thinks that bond yields look appealing, particularly in the investment grade corporate space where there is the opportunity to generate some extra yield over and above cash, but warns that it could still be a bumpy ride from here, so investors should tread carefully.

Bond Funds To Consider

When it comes to the individual funds he suggests Artemis Corporate Bond, which focuses on investment grade bonds and is run by the highly experienced Stephen Snowden. The fund is actively managed with the manager looking to take advantage of pricing anomalies in the market both in the short and long term. It is yielding over six percent and is well positioned as a core long term holding.

Another option that he suggests is the Royal London Investment Grade Short Dated Bond fund that is managed by a highly experienced team who ensure the portfolio is highly diversified with over 300 positions.

“For those investors nervous of further rates rises, keeping duration short is a way of protecting against the worst of the increases. This fund invests in bonds that have less than five years to run until maturity and therefore are less sensitive to interest rate rises.”

Alternatively there is M&G Emerging Market Debt, which has exposure to a wide range of countries that have very different characteristics to the UK and Europe, with their economies at different points in the cycle. It yields over 6.5% and would add diversification to traditional fixed interest holdings.

“With much lower debts in many cases and growing economies, bonds here may not be quite as risky as at first glance. Countries such as Mexico, Brazil, Indonesia and Singapore all appear with exposure to bonds issued in both US dollars and local currencies.”