Global bonds climb despite downgrades

The safety of bonds took a hit 12 months ago. But they have proved an essential part of investors' plans

After taking a massive hit from the historic United States ratings downgrade 12 months ago, global bonds have staged a remarkable recovery.

Funds containing the bonds offered reliable returns after the stock market crash five years ago. In fact over five years they are the third best performing sector behind two similar bond-focused UK gilt fund sectors.

But their attractiveness was challenged when the United States' investment rating was downgraded for the first time in its history on 6 August 2011. The credit rating agency Standard & Poor's cut the rating on concerns over budget deficits.

But after a wobbly few months when returns looked less good, the funds have responded by posting a 4 per cent climb since the downgrading. In fact, despite continuing concerns about the euro countries, global bond funds were the third best sector over the last three months.

"The higher quality government bonds will remain a safe haven for investors, even if they do lose their top status – it's all relative," said Darius McDermott of Chelsea Financial Services.

Part of their continuing good performance is the controlled management of currency risk, explained Jim Leavis, head of retail fixed interest at M&G Investments. "Global bond funds have benefited from the breadth of their investable universe," he said. "On top of actively managing their bond investments, managers have also been able to use currency exposures as an important driver of returns."

The fact is that investors are still flocking to US bonds as a relatively safe haven, against the background of fluctuating global markets and the continuing eurozone crisis. But while global bonds are US-bond heavy, many spread their investment across the globe. Consequently, would they be hit by a euro collapse?

"If a credible solution were found to the crisis, then Spanish and Italian bonds would offer a great opportunity," said Martin Harvey, manager of the Threadneedle Global Bond Fund. "But a messy conclusion to the crisis would send shockwaves through the global financial system."

The question for investors is then what will happen in Europe and how will that affect bonds? "We suspect that if quantitative easing has finished, then bond yields will rise quite significantly over the next 12 months," said David Coombs, of the Rathbond Strategic Bond fund.

But longer term, bond funds will fall from being near the top of the performance tables, warned Phil Milburn, of Kames Capital Strategic Bond fund. "The returns from bonds in recent years have been abnormal. Normally the majority of returns comes from income, but this hasn't been the case. In the future, returns will be lower."

However, Darius McDermott believes bonds will always have an important role as part of an investment portfolio, for diversification and income.

"The global bond sector is very diverse, encompassing global, European and emerging market bond funds, so investors need to look carefully at a fund before investing, to make sure they are clear about its remit," he advised.

"My favourite fund in this sector is the Old Mutual Global Strategic Bond fund. There are also funds in the UK strategic bond sector which have an international slant. Of these I like the Kames Capital Strategic Bond."