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With inflation at more than 5pc in the UK and 7pc in America, and investors expecting multiple interest rate rises this year, the outlook for bonds is – on the surface – extremely negative.
Bonds pay a fixed income whose value is eaten away by inflation. The price of existing bonds also falls when interest rates go up as investors can get a better deal from newly issued bonds.
However, not all funds will do poorly under these conditions and bonds are still essential as a cushion against stock market falls. Here are the funds to buy as rates go up.
Twentyfour Income Fund
While traditional bonds, issued by companies and governments, may suffer when interest rates go up, investors can still profit if they look for income from more niche corners of the market.
Thomas Becket, of Psigma Investment Management, said the Twentyfour Income Fund, an investment trust with the ticker TFIF, would deliver for investors. It buys “asset-backed securities”, which tend to be bundles of ordinary residential mortgages packaged together and sold on by the original lender.
“Almost all asset-backed securities are 'floating rate' instruments which means the coupon they pay rise in-line with interest rates. As a result they are less affected by interest rate risk and tend to be far less volatile in environments when rates are changing.
“Due to their complexity, they also tend to offer a higher yield than traditional bonds with otherwise similar characteristics. Currently the fund offers a yield of 5.5pc," said Mr Becket.
Man GLG High Yield Opportunities
For Darius McDermott, of fund shop Chelsea Financial Services, selecting a fund with an excellent and experienced management team is the most important thing to consider at the moment.
"The Man GLG High Yield Opportunities fits the bill. Its manager Michael Scott has worked in the industry for 20 years with an excellent track record navigating the risky high yield bond sector. Yields are higher but so is the risk of default," he said.
The fund pays around 6pc, which will help investors counter the effect of inflation. Despite being "high yield", which is the riskier end of the bond market, defaults are low and predicted to remain so, according to Mr McDermott.
Aegon Strategic Bond
Mr McDermott also recommended the Aegon Strategic bond fund, which can invest anywhere in the bond world. Its co-manager manager, Alex Pelteshki, said bonds would be much more volatile this year but that was good for an active manager with a "go anywhere" approach.
“The withdrawal of central bank money printing will have a broadly negative impact on bond markets but this volatility will be a good environment to grow your money,” said Mr Peltseshki.
The fund prefers high-yielding debt at the moment, as well as emerging market debt, which means that income can match the inflation rate.