The last 12 months have seen fixed income assets fall in value at different times, for different reasons. The onset of the covid-19 crisis in March 2020 saw credit spreads widen significantly, negatively impacting the performance of credit-focused bond funds as investors dashed for the safety of government bonds. These assets outperformed as yields tumbled.
The story in 2021
However, in 2021, we have seen the reverse of this. With economies opening up and growth returning, higher inflation expectations have driven up government bond yields sharply in 2021. These higher rates have hurt the performance of government bond funds, as well as longer duration fixed income assets. As a result, funds with exposure to credit spreads have outperformed. What do we believe is the best strategy for protecting client capital in this kind of environment?
For us, the key is maintaining a shorter duration, as well as ensuring that the assets selected have a sufficient yield to absorb the negative price impact of rising rates, whilst still delivering a positive return. To highlight this, we can use the example below.
Consider the decision to invest in a bond that has a duration of 3 years (the same duration as the iBoxx Sterling Non Gilt 1-5 yr Index); we can choose either an insurance bond with a spread of 125bps and yield of 1.40%, or a supranational bond with a spread of 20bps and yield of 0.35%.
If held to maturity, assuming no defaults, the return on the insurance bond over its three-year life would be 4.20% versus 1.15% on the supranational bond. Furthermore, if we consider a 1 year horizon we can also see that the higher yield on the insurance bond makes it more able to withstand increased interest rates:
Even in instances when spreads widen, the higher yielding bond delivers a better representative return across all scenarios. The important caveat is that you need to be comfortable with the credit quality. Another thing to bear in mind for short-dated bonds is that the roll down effect on spreads (i.e. spread declining as you get closer to maturity) is very powerful.
Source: Canada Life Asset Management research, Markit & Bloomberg, May 2021. For illustrative purposes only. Not to be taken as a forecast for performance.
LF Canlife Short Duration Corporate Bond Fund
This is what Mike Count and Steve Matthews, managers of the LF Canlife Short Duration Corporate Bond Fund are aiming to deliver for investors. Their philosophy is founded on the strong belief that the avoidance of bad credits is critical to success, with credit selection driven by the in-depth knowledge of our experienced fund managers and in-house credit analysts. The Fund is managed with a conservative, low-risk style, that focuses on capital preservation and sustainable income.
This style is reflected in its drawdown and volatility profile relative to its benchmark, as well as the returns it has delivered in rising rate environments. The Fund has an average 3 year rolling volatility of 1.2, versus the Markit IBoxx Non-Gilt 1-5 Year Index volatility of 1.4.
Source: Morningstar Direct, as at 31 May 2021. I Acc GBP share class.
The impact of spread duration
You will notice that the Fund has consistently delivered better downside protection than the Index – with the exception of during the covid-19 crisis. This was because we were overweight credit spreads, maintaining no exposure to the ‘safer’ Sovereign, Supranational & Agency (SSA) sectors given their unattractive spread profiles. Whilst we were disappointed to underperform, we believe that these positions were the best placed to deliver returns, a decision that has paid dividends since.
This has enabled the Fund to deliver the 4th best return within the IA Sterling Corporate Bond sector in 2021 so far (C Acc GBP share class, to 31 May 2021), in a market in which many fixed income funds have seen negative returns. The comparative performance of the discretionary share class is also shown below:
Source: Morningstar Direct, as at 31 May 2021. I Acc GBP share class performance, in pound sterling, with net income reinvested and no initial charges. This share class was launched on 13 March 2017. The performance of other share classes may differ. Past performance is not a guide to future performance.
The Fund currently has a duration of 2.4 years (versus 3 years for the Index), an average credit rating of ‘A’ and an underlying yield of 1.6%. In the current environment, we believe this offers fixed income investors exposure to high quality sterling credit, without the need to take on significant interest rate risk. In addition, we believe the Fund offers an attractive source of income – at a time of low yields – while maintaining a rigorous focus on credit selection and the discipline to refrain from chasing yield at the expense of risking your capital.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at https://www.canadalifeassetmanagement.co.uk/.
Canada Life Asset Management is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Credit ratings are internal and assigned by Canada Life Asset Management. Ratings will generally be in line with the major external rating agencies and should not be higher than the highest of these. Canada Life Asset Management will assign ratings to bonds that do not have an external rating.
The Distribution Yield reflects the amounts that may be expected to be distributed over the next twelve months as a percentage of the mid-market unit price of the fund as at the date shown. It is based on a snapshot of the portfolio on that day. It does not include any preliminary charges and investors may be subject to tax on distributions. The Underlying Yield reflects the annualised income net of expenses of the fund (calculated in accordance with the relevant accounting standards) as a percentage of the mid-market unit price of the fund as at the date shown. It is based on a snapshot of the portfolio of that day. It does not include any preliminary charge and investors may be subject to tax on distributions.
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Expiry 31 May 2022