Royal London Sterling Extra Yield Bond – removed from Foundation Fundlist

We still rate the managers of this popular high yield bond fund highly, but a growing fund size could inhibit options in more esoteric parts of the market.

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  1. Rob Morgan

High yield bonds can play a specific role in an investor’s portfolio. They typically offer a high level of income, and are less exposed to the adverse effects of rising interest rates than other fixed income sectors. However, other risks are greater. They invest in companies deemed less creditworthy, and which have a higher chance of bankruptcy or distress resulting in loss of income or capital. They also tend to be more sensitive to economic conditions, as any downturn can result in rising defaults from these more vulnerable businesses.

Another concern about the high yield bond market is ‘liquidity’, in other words the ease at which you can buy and sell. High yield bonds can be illiquid, especially in times of market stress, which means that it can be difficult to trade and prices could be erratic.

Eric Holt, manager of the Royal London Sterling Extra Yield Bond Fund, has successfully operated  in this part of the bond market for many years. We believe the quality and experience he offers, alongside the broader fixed income team at Royal London, is second to none. The yield of the fund remains attractive, currently 5.7% variable, not guaranteed, and the fund has provided a strong record of performance since it first appeared on our Foundation Fundlist (our list of preferred funds for new investment) in January 2015. Past performance is not a guide to the future.

Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics.

In particular, Mr Holt has been a successful investor in unrated bonds, which are issued by companies that don't have a credit rating from an agency such as Moody’s. These tend pay higher yields to compensate for the lack of official rating. Typically, there is nothing untoward about a bond being unrated. Agencies and charge a fee to rate their debt, and some simply decide not to pay. This means investors have to do all their own research on the financial prospects of the underlying company, and it affords specialist investors the opportunity to discover bonds they believe are higher quality than widely assumed.

Overall, a large chunk of the fund tends to be invested in unrated bonds. However, going forward we believe the growth in the fund’s size may start to limit the number of unrated and other esoteric opportunities the managers can exploit. At nearly £2.2bn the fund is among the largest in its peer group having seen substantial growth in assets – by about 40% in the past two years – due to its popularity and strong returns. Should this continue we worry that the size could inhibit the ability for the managers to add value in an area that has historically been a fertile hunting ground.

This has led to a loss in conviction towards the fund among our Research Team, and accordingly we have taken the decision to remove the fund from our Foundation Fundlist. The fund has also been removed from the ‘Adventurous Income’ Foundation Portfolio, replaced by Investec Diversified Income, a high yielding multi asset income fund.

Past performance is not a reliable guide to future returns. This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

 

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