Index trackers in the IA Global Bond, UK Gilts and Global Emerging Market Bond sectors have delivered strong returns to investors over recent years, according to FE data, to the extent where many are outperforming their active rivals.
Bond have enjoyed a three-decade bull run which was fuelled in more recent years by record low interest rates and the launch of quantitative easing programmes by the world’s central banks. However, the prospect of rate rises from the Federal Reserve and the Bank of England threaten to cast a dark shadow over the asset class.
Most investors opt to take active exposure when it comes to bond investing, reflecting the sheer size of the investment universe, the desire to retain a degree of flexibility and, more recently, the concern about significant headwinds. But passive investing is a growing trend, so with this in mind FE Trustnet puts the bond sectors under the spotlight for index investors.
FE Analytics shows there are six passive funds in the IA Global Bonds sector and five of these are sitting in either the first or second quartile over the past year. Most of the six are outpacing their average peer over shorter time frames as well but only two of the four with long enough track records are outperforming over three years.
Performance of passive IA Global Bonds funds vs sector
Source: FE Analytics
A standout passive fund in this sector is Vanguard Global Bond Index, which is first quartile over one and three years, as well as over three and six months, and second quartile over five years. It is either first or second quartile in four of the past five years and is the sixth highest returning member of its sector over 2015 so far, out of 146 funds.
The $3.7bn portfolio tracks the performance of the Barclays Global Aggregate Float Adjusted Index, which covers global government, government-related agencies, corporate and securitised bonds. This means its largest geographical exposure is to the US, followed by Japan, France, Germany and the UK.
Ben Gutteridge, head of fund research at Brewin Dolphin, is a fan of the fund as it gives exposure to US bonds and the dollar, which could prove to be a good hedge against the deflationary forces that have recently rattled markets.
“Our preferred means to achieve a diversified position in the global bond market, yet retaining a significant weighting in US bonds, is via the Vanguard Global Bond Index fund. This is a passive strategy, but is one of only very few options providing the exposure we most specifically require,” he said.
“Most active managers are avoiding US bonds giving the longer term trends in the US economy and what this might mean for treasuries. Managers are, instead, finding value in areas such as emerging markets – particularly Mexico. There is fundamental value here but such is the nature of the investment that these bonds will suffer selling on days of risk aversion. With emerging market risk still very much on the table as China continues to slow, the Vanguard proposition offers a better balance for portfolios.”
Gutteridge adds that the fund is also “very keenly priced”, with its clean ongoing charges figure standing at just 0.15 per cent.
IA Global Bonds isn’t the only sector where there are examples of passives showing better track records than the average fund. In the IA UK Gilts sector, for example, five of the six trackers are either top or second quartile over one and three years while all five with five-year track records are in the top two quartiles.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Another Vanguard offering appears to be the most consistent outperformer as the Vanguard UK Government Bond Index fund is showing top-quartile total returns over one, three and five-year time frames as well as over three and six months.
This £773.7m fund hold the top FE Passive Fund Rating of five and appears on the FE Research team’s Select 100 list. Our analysts note that the fund directly owns the underlying securities of its benchmark, which is the simplest approach but depends on the manager’s efficiency in reflecting index changes, and does not engage in stock lending, which lowers risk but limits potential returns.
Vanguard UK Government Bond Index has a clean OCF of 0.15 per cent.
There’s only one tracker in the IA Global Emerging Market Bond sector –L&G Emerging Markets Government Bond (US$) Index, which offers exposure to emerging market government debt – and this is currently in the top quartile over one year, although it does not have a track record greater than this.
The fund has a 0.29 per cent OCF.
Within the IA Sterling Corporate Bond sector there are a number of index trackers that sit in the top two quartiles over various time frames. Two stand out: Vanguard UK Investment Grade Bond Index, which is first quartile over one, three and five years, and BlackRock Corporate Bond Tracker, which is in the second quartile over these periods.
Performance of funds vs sector over 5yrs
Source: FE Analytics
However, while government bond trackers are tipped by some investment professionals, there is greater caution over the use of passives that track corporate bond indices. 
Mike Deverell (pictured), investment manager at Equilibrium Asset Management, has used bond trackers in client portfolios before but stresses that there are “things to be wary of” with this approach.
“A gilt or US treasury tracker is fine, as long as you know what you’re getting in terms of duration or average maturity –whether you’re buying short or long maturity, or an all-stocks fund,” he said.
“However, the way ‘market cap’ weighted corporate bond trackers are constructed is something investors should be aware of. You effectively allocate the most to the company that has the most bonds in issue. To put it another way, you are lending most to the company with the most debt.”
“Nobody would construct a bond fund in that way. We prefer active funds in fixed interest for this reason.”
