The Vontobel Fund II – Fixed Maturity Emerging Markets Bond 2 invests mainly in emerging market bonds in hard currencies and aims to offer a higher spread, yield and coupon relative to comparable bonds in developed markets.

It also focuses on optimising the level of spread in short-maturity emerging market bonds.

With a fixed maturity of three years, the fund targets an average investment grade rating and a target yield maturity of 7%, depending on market evolution.

The seeding period for the fund began on 2 April and will close on 14 May, which is also the launch date. The fund’s maturity date is 14 May 2027.

Sergey Goncharov, portfolio manager at Vontobel, said: “Choosing a three-year maturity aligns with current market conditions, which are favourable for emerging market bonds. With an expected downward trend in US interest rates, investors have the opportunity for an attractive risk-return ratio over a fixed time horizon, locking in higher yields.”

The fund is registered for distribution in the UK, Austria, France, Germany, Liechtenstein, Luxembourg, Switzerland, Italy and Spain.

Researchers at the firm noted in the report titled ‘Multi-Asset Investing: A Difficult Sport’ that many multi-asset funds have struggled to beat their benchmarks in recent times.

They noted the average ‘moderate’ global allocation Morningstar category fund trailed the euro moderate global target allocation index by 2.19% annualised over the past 10 years.

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The lure of the balanced portfolio has been its ability to limit losses in challenging stock markets through bonds’ negative correlation, the report noted. But in 2022, both stocks and bonds lost ground.

This led some to suggest the 60% equities, 40% bonds portfolio is past its due date, Morningstar said. The stock/bond correlation changes through time and, besides correlations, valuations matter. At the start of 2024, the bond market has been repriced and is now offering some of the highest yields seen for a long time.

Thomas De fauw, senior manager research analyst, and author of the report, said: “Strategic asset allocation is the main driver of a portfolio’s return and explains a great deal of the excess performance versus the benchmark. Looking at the European multi-asset universe we see a broad range of allocations in each of our categories.

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“But benchmarking a multi-asset strategy differs substantively from a strategy focused on a single asset class as the many dimensions of multi-asset strategies complicate the analysis. Moreover, for objectives-oriented funds, such as multi-asset income or environmental, social, and governance-focused funds, there’s a specific investment outcome to consider.

“All the work that goes into achieving those goals is not always captured through benchmark-relative performance, nor is it always clear which benchmark to choose,” he added.

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Inflation didn’t miss by much in the US – 3.2% versus 3.1% predicted. In the Eurozone, inflation climbed to 2.9% in December, from 2.4% in November, but was back down to 2.8% in January. In the UK, inflation rose marginally to 4% in December, up from 3.9% in November, after economists had predicted a slight fall.

Nevertheless, it has been enough to trouble the bond markets. The US 10-year treasury yield is back above 4%, and shorter-dated yields have moved even higher. The UK 10-year gilt yield has moved from around 3.5% at the start of the year to just under 4% today and the 2-year from 4% to 4.5%. This disrupts the view that government bonds are a one-way bet for the year ahead.

See also: It’s time for multi-asset managers to ditch bond proxies

The US Federal Reserve has pushed back on market expectations for a rate cut in March, saying that “the committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%”.

Nevertheless, most believe that rate cuts are deferred rather than cancelled. Anthony Willis, investment manager on Columbia Threadneedle’s multi-manager team, says: “Chair Jay Powell spoke positively about the progress made so far but said there was a need to have more confidence on the disinflation path”. The Fed is “not looking for better data, but a continuation of the better data” that has already been seen. Powell said that a March cut is not the most likely case, because the committee is unlikely to have hit that level of confidence by then.

“Futures markets are pricing only a 35% probability of a cut in March – though the Fed will have two more inflation data points to digest by then. Powell’s comments suggest that if inflation remains on track, then even if March is not likely, rate cuts are coming soon,” adds Willis.

See also: Facing the inflation dilemma head on

Jim Leaviss, manager of the M&G Global Macro Bond fund, also believes rate cuts are still likely: “Inflation has started collapsing – both core inflation and headline inflation. The numbers that the Fed looks at – core PCE inflation – are back down towards 2%. It is going in the right direction.”

Inflationary risks

That said, Leaviss also believes there may be longer term risks to the current benign inflation picture, particularly in the US. He points out that there is usually a balancing mechanism for government debt. Governments borrow more when the economy is weak; and when the economy is weak, inflation is falling and interest rates are generally coming down as well.

However, he adds, “this relies on a world in which governments borrow more when economies are weak, not where they borrow more to juice an already strong economy.” The US has seen two quarters of 4-5% growth, and its employment market is very strong. Nevertheless, he believes that widespread disgruntlement with rising prices is likely to usher Donald Trump into the White House, and that tax cuts are likely to be his priority once he gets there.

Tax cuts have historically been a significant contributor to rising debt to GDP. Leaviss says Trump’s election is likely to be inflationary and the US government will have to borrow more at higher bond yields.

Inflation protection?

Charlotte Yonge, assistant manager on the Personal Assets Trust, is also alert to the risks inherent in US borrowing: “The US government is spending money like it’s going out of fashion. This has provided a great fillip to growth. The fiscal deficit – the amount by which government expenditure exceeds receipts – was $1.3trn for the first three quarters of 2023, or nearly 5% of GDP.  We have never seen this level of government spending outside of a recession or its immediate aftermath.  On a gross basis, the fiscal outlay relative to the size of the economy is approaching a level consistent with the peak in government support provided during the Second World War.”

She believes this phenomenon is consistent with a multi-decade long trend and is not unique to America.  It is both a symptom and a cause of lower pain thresholds on the part of electorates around the world. She adds: “We expect that the next recession will see a fiscal response on top of a monetary one, such that the benefits extend beyond owners of capital to labour as well. This, as we saw with Covid, is likely to mean inflation for goods and services on top of asset price inflation.  Governments’ increased readiness to respond to economic hardship will help define the shape of the next recession and subsequent rates of inflation.”

The consequence of this shift is likely to be more volatile and structurally higher inflation than we have experienced over the course of the last 10-15 years. In response, the trust now has around 40% in index-linked bonds, mostly in the US. This is well above the trust’s long-term average of around 30%.

For Leaviss, the bond market is still good value, and they are keeping a watching brief on the election outcome. He adds: “The Fed says that long-term interest rates, based on demographics, technology, globalisation, and those long-term factors that determine how much we save and invest, will be around 2.5%. The treasury market thinks it’s more like 5%. We’ve never seen this degree of dislocation.” As a result, he is focusing on longer duration government bonds, believing this is where the opportunity lies.

Bonds markets have re-set since the start of the year and now reflect less optimism on rate cuts and falling inflation. Inflation is unlikely to bounce back significantly, but there are always unpredictable elements, such as the oil price, and markets are jumpy. It can still be the year of the bond, but investors will need to be selective.

This article was written for our sister title Portfolio Adviser

While the bounce back in bond income has made owning bonds for their income-generating qualities more desirable, McEntegart said the knock-on effect has also been to free up capital from income-generating ‘bond proxy’ equities into growth-focused companies.

“Being less reliant on equities for income offers a chance to reshape that component of the portfolio by geography, industry and theme,” he said.

“Low average yield from the US equity market is no longer the issue it was,” he added. “Instead, its growth potential is something that can be more readily tapped.”

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For example, McEntegart said it would have been difficult to own companies such as Microsoft, which is developing AI and has a 49% stake in ChatGPT, and Broadcom, a global leader in semiconductors and infrastructure software, when income was scare since they yield less than 1% and 2% respectively.

“Growth themes in other markets are not off limits either,” he added. “Some 7.4% of our portfolio [25% of equities] is now invested in eight businesses benefitting from the technology and AI theme which has been an important growth engine while other parts of the market have faltered.”

Meanwhile McEntegart argued the reset in bond prices has also enabled multi-asset managers to look to bonds for other qualities.

“Adding to bond allocations, particularly investment grade, allows for lower volatility,” he said. “When uncertainty remains significant and asset correlations high, it is surely better to tilt towards the contractual income of bonds and their pull-to-par nature which aids total return.

“Markets wax and wane with the economic cycle, as we have seen in the ten years since the fund’s inception,” he added. “Navigating that in real time is key.”

Both funds were given a ‘red’ rating for performance, meaning they will undergo changes in order to improve value to investors.

Of the 13 HL funds assessed, three strategies were given an amber rating which means they have delivered value to investors but require attention.

Those funds were the HL Multi-Manager High Income, HL Multi-Manager UK Growth, and HL Multi-Manager European.

The assessment of value (AoV) process has been mandated by the Financial Conduct Authority (FCA) since 2019, requiring firms to assess their product ranges on whether they have delivered value for money for investors.

Strategy overhauls

On the Asia & Emerging Markets fund, HL noted performance was “disappointing” due to “poor stock selection”, as it missed out on a rally favouring Taiwanese and Indian stocks over cheaper Chinese and Hong Kong-listed shares.

The fund was down 3.3% in 2023, compared to the average IA Specialist sector fund which rose 7.9%.

HL said that it had removed two managers on the fund in order to improve outcomes in the longer term. They have added Invesco Global Emerging Markets as part of those changes.

“We currently believe this fund is not delivering value to investors through performance. The upgrades to the investment processes and the changes detailed have been made to enhance future performance and we continue to review the fund proposition,” HL noted.

On the red-rated Strategic Bond strategy, HL added: “Over the last 12 months we have executed a near-total overhaul of our portfolio. This largely reflects the significantly more attractive yields on offer from bonds compared with a year earlier. It also reflects a desire to have more control over the fund’s allocations.

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“Previously, we delegated such decisions to managers of ‘strategic’ bond funds. Going forward, we will decide how much we wish to allocate to government bonds, investment grade corporate bonds, higher-yielding debt and bonds from emerging markets.

“We believe these changes will allow us to deliver the fund’s objectives and to improve long-term performance relative to the IA £ Strategic Bond peer group aided by high-calibre bond fund managers, including those running global funds and with a broad opportunity set.”

This article was written for our sister title Portfolio Adviser