Shillito (pictured), director at SG Wealth Management, says he is concerned about the future of bond funds given their low yields and that cautious investors need to re-evaluate the true risk of these assets.
Because of that, he has been looking for alternative "bond proxy" funds instead of using traditional fixed income products for his more cautious clients. "Because of the somewhat uncertain bond market, we are seeking out other funds that are not classified as fixed income funds, but are essentially quasi-bond structures," he said.
"There hasn’t been a wholesale sell-off in bonds as yet, but we have to be mindful. Especially with cautious investors who have to hold fixed income, because you are not going to get much thanks if people are stuck in bonds."
"One of the funds we are using is the Freehold Income Trust, which has recently gone through a regulatory change. The other is one we have used in the past, but are now looking more actively at: the TwentyFour Monument Bond fund."
"It invests in European – not US – residential mortgage-backed securities. Because of the assets they invest in, the fund will not be affected by a hike in interest rates as they are floating rate notes."
"It is also an inflation hedge, though not many people seem too worried about that at the moment," he added.
The £87.3m PFS TwentyFour Monument Bond fund sits in the IMA Specialist sector and was launched in August 2009.
According to FE Analytics, it has returned 15.52 per cent since its inception while its benchmark – the LIBOR GBP 3m index – is up 2.98 per cent.
Performance of fund vs index since Aug 2009
Source: FE Analytics
The fund also delivers a yield of 3.06 per cent.
Obviously, there will be plenty of investors who are wary of a fund that invests in mortgage-backed securities. They were one of the principal drivers of the financial meltdown in 2008 and many experts still see them as an area of the market to steer clear of.
However, while Shillito accepts that investors will be suspicious of investing in such a fund, he says the team behind PFS TwentyFour Monument Bond invests in the safer parts of the asset class.
"It’s a really good point that for investors thinking of buying into a fund like this, the reasons for doing so need to be explained well as mortgage backed securities were a major component of the crisis," he said.
"At the time, only a handful of people knew what was going on with the likes of AIG, offering credit default swaps on them without realising they were effectively worthless. However, the TwentyFour story is very powerful and there is real evidence that there is safety in the assets they hold."
One of the major reasons why mortgage-backed securities became toxic in the first place was because of the way they were rated.
Higher-quality mortgages were packed together with mortgages from people who had a lower credit rating and therefore a higher chance of default.
Nevertheless, many of these securities were given investment grade status from the rating agencies despite the obvious risks surrounding them.
Shillito understands why investors would be concerned about a repeat of the past, but he says that the fund’s management team only invests in the best-quality debt using its own analysis.
"They don’t rely too heavily on the likes of Fitch and Moody’s and have a very robust due-diligence process, as let’s be honest, the rating agencies didn’t cover themselves in glory at that time did they?"
According to the fund’s factsheet, PFS TwentyFour Monument Bond only invests in the top end of the credit market.
"The assets in the portfolio will be rated at least BBB- (or equivalent) at the time of investment by one or more of Standard & Poor’s, Moody’s and Fitch, but with a strong focus on the more highly rated securities available."
A total of 64.3 per cent of the fund is invested in the UK and it also has some exposure to the Netherlands, Ireland and Spain.
The PFS Twentyfour Monument Bond fund has an ongoing charges figure (OCF) of 1.37 per cent and requires a minimum investment of £5,000.
The Freehold Income Trust, which currently yields 4.25 per cent, invests in freehold leases and has recently become a Property Authorised Trust, and therefore can be marketed to retail investors. The fund’s manager, Nigel Ashfield, explained how it worked in an FE Trustnet article earlier this year.