Is your bond fund quietly investing in shares?

Is your bond fund quietly investing in shares?

Some fund managers have the option to invest outside their main area of expertise. Should you be worried, asks Kyle Caldwell.

Some funds managers have been straying outside their normal markets.  Photo: JLImages / Alamy

By Kyle Caldwell

7:00AM BST 02 Sep 2013

Professional fund managers are usually endlessly upbeat whether the market is rising steadily or plunging headlong. But now – after several years of healthy stock market gains, during which world economies have not recovered as swiftly – a growing number of fund managers are admitting they can no longer see value in the markets they specialise in. In other words, prices are too high. This has led some to stray outside their normal remits – with the result that the make-up of the fund is no longer the same as when many investors first put money with the manager.One example of this is M & G’s respected bond manager Richard Woolnough. Despite being garlanded for his success at running portfolios of bonds, Mr Woolnough is currently backing shares. He manages the popular M &  G Optimal Income fund, in which savers, both private and institutional, have £15bn invested. The fund sits within the “strategic bond” sector, where rules limit equity holdings to a maximum of 20pc. Mr Woolnough is currently holding 13pc of the portfolio in shares – his highest ever weighting.

“Bonds are where investors face their biggest problem at the moment,” said Ben Yearsley of stockbroker Charles Stanley. After years of rising prices, bonds now yield little income and the potential for gain – the possibility of future increases in capital value – is “limited”, Mr Yearsley said. “On the other hand, the downside could be quite severe. Bond managers moving into equities demonstrates that bonds as an asset class are really expensive.”

Other managers who have become bearish on their investment markets’ fortunes include a number of global emerging market fund managers who have been buying developed market stocks. One of the best performing funds in the sector, the £4bn First State Global Emerging Markets Leaders, managed by Jonathan Asante, has increasingly been taking this approach.

This has been of great benefit to investors in recent weeks as shares listed in Asian and other emerging markets have suffered sharp falls.

Mr Asante has loaded up on stocks listed on Western exchanges, such as London’s, but where much of the underlying revenues still derive from emerging regions. Companies such as Unilever, which he owns, do a large proportion of their business in Africa and India but the share price tends to rise and fall more in line with the FTSE, thanks to its London listing.

Top Asia fund manager Hugh Young, of Aberdeen Asset Management, has also stated in recent months that he is struggling to find any value opportunities in the region. In some of his portfolios he holds cash, which he says is preferable to buying stocks at too high a price. “There is simply not an inexhaustible supply of good companies to own,” he said earlier this year – before emerging markets were gripped by the latest turmoil.

But if top fund managers are being forced to look beyond their usual remits, are they taking greater risk with clients’ money?

Gary Reynolds, chief investment officer at wealth manager Courtiers, said: “If you have bought a bond fund to diversify your bets away from stock market volatility then you surely do not want your fund manager to be buying shares. This leaves investors with a big dilemma, as they are not getting what they bought, and in this scenario they should probably sell.”

Gemma Godfrey, head of investment strategy at rival manager Brooks Macdonald, warned that some investors would be unaware of the gradual change in their portfolios – and any added risk it represented. “When managers deviate away from their market it can result in investors taking on more risk than they first thought,” she said. “The key is to regularly review your investments and check they are doing the job you expected them to do as part of your wider, diversified portfolio.”

DIY investors face a difficult challenge to ascertain whether their fund is veering away from what was originally described on the tin. Monthly fund updates are provided by fund management groups, but the information is often several months out of date. Another stumbling block is the fact that these groups disclose only a small portion of the fund’s investments.

This is especially the case with “open-ended funds” such as popular unit trusts or their close cousins, “Oeics”. By contrast, investment trusts, which are listed on the stock market and more accountable to their investors, tend to provide far more information about where and how they invest.

But if investors are anxious about fund managers gradually altering their remit they should select a fund where there is little or no flexibility to invest outside the mandate, said Mr Reynolds.

Mike Deverell of wealth manager Equilibrium said several highly respected managers had lost clients’ money in the past by “wandering” away from their mandate. He said a number of popular funds under the “UK equity income” banner had stumbled thanks to their holdings overseas. One example is the £800m Neptune Income fund, managed by respected investment veteran Robin Geffen, where performance has suffered in recent years owing to Mr Geffen’s putting money into emerging markets such as Russia.

“We generally do not like fund managers straying too far from their mandate,” Mr Deverell said. “For example, the rules state that a UK equity income fund has to aim for a certain yield and hold 80pc of its assets in UK equities. Even so, this allows a hefty 20pc of assets to be invested elsewhere. The Neptune Income fund is one that has tended to make full use of this flexibility, investing the full 20pc outside Britain. It has had a significant exposure to emerging markets in the past, which was one of the reasons it performed so well in the run-up to the financial crisis but also explains why it has not done so well since.”

Do you know what you are buying?

Direct investors who make their own fund choices and use brokers or supermarkets (see our guide to the best) need to bear in mind that some funds do not necessarily fully adhere to the remit their name suggests.

The following list highlights some common “misnomers” in the fund world.

* Bond fund managers can invest up to 20pc of their portfolios in equities. Managers are only required to invest a minimum of 80pc in sterling denominated bonds.

* So-called “absolute return funds” do not guarantee an absolute return. The fund management trade body, the Investment Management Association, has recently moved to dispel this myth by changing the fund sector name to “Targeted Absolute Return”, but the majority of the funds still retain the words “absolute return” in their name, even though many have suffered substantial losses.

* Equity fund managers can invest 20pc of their portfolio outside of their “home market”. So a UK-labelled fund could invest 20pc of its assets in US shares, for example.

* The majority of global equity funds are not as global as you might think. Some have heavy exposures to the US and UK, so you may be better off opting for a country specialist fund manager.

* Property fund names can also mislead investors, which often fail to distinguish whether the fund is invested directly in property or – very different – in property shares.