When central banks stop printing money the bond market faces turmoil. Which bond funds are safest?

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Last week we looked at some of the funds that were most at risk of a bear market in bonds . Today we’ll name the bond funds that investment experts say are best placed to ride out any storms.

All financial markets have been distorted in recent years by the mass printing of new money by central banks. The Bank of England, its American equivalent, the Federal Reserve, and others have used most of the cash created by quantitative easing or QE to buy bonds. The arrival of such an enthusiastic new buyer in the bond market has, naturally, pushed up prices.

When QE ends, or even passes its peak, investors everywhere expect this bull market to go into reverse.

Although the Fed gave QE a stay of execution last week, it has made clear that it will wind down the programme when it believes that America’s economic recovery is sufficiently well established.

The withdrawal of this artificial stimulus derided as a sugar rush by some is very likely to lead to a fall in the bond market.

Paul Taylor of McCarthy Taylor, a financial adviser, said: Bonds are the Lance Armstrong of investments so hyped up on performance-enhancing QE that when they come off, the withdrawal symptoms will be painful.

With this in mind, now may be the ideal time for holders of bond funds to check the suitability of their choices to the new investment landscape. Below are our experts’ choices of bond funds for a bear market.

Jason Hollands of Bestinvest, the fund supermarket, suggests that investors steer clear of funds that hold investment-grade corporate bonds, such as Invesco Perpetual Corporate Bond and M&G Corporate Bond.

Both are very well managed funds with strong teams but their remits are restricted to parts of the market that could see significant volatility, he said. Investors could stick with the same teams but move into more flexible alternative funds managed by them.

More bond fund tips

His pick among M&G’s bond funds was M&G Optimal Income. It has a flexible remit to shift buy bonds of different credit ratings and time to maturity, he said. He also liked the Invesco Perpetual Tactical Bond. This is an unconstrained fund consisting of ‘best ideas’, run by star managers Paul Causer and Paul Read. It is able to invest right across the spectrum of bond types and can use derivatives too, Mr Hollands said. He also tipped the Legal & General Dynamic Bond fund.

Another of his recommendations was the Axa US Short Duration High Yield fund. On average, its holdings are three years from their repayment date, which helps reduce risk. This is because the bonds have a known value the par value in three years’ time, assuming the issuer stays solvent, so the market price is unlikely to deviate from that figure in the interim. The fund yields 4.5pc.

Mr Hollands’ final choice was the PFS TwentyFour Dynamic Bond fund. TwentyFour is a ’boutique’ fund manager specialising in bonds whose principals come from trading backgrounds, he said. The fund has a ‘best ideas’ approach and significant exposure to asset-backed securities. It also uses derivatives to help hedge risk.

Mr Taylor also tipped an Invesco Perpetual fund managed by Mr Read and Mr Causer Invesco Perpetual Monthly Income Plus.

He said the managers assessed how sensitive their holdings were to the economic climate and were not afraid to choose holdings outside their normal remit if there was an opportunity for gains. Up to 20pc of the fund can be allocated to shares, which are chosen by Neil Woodford, the renowned equity income fund manager.

This fund is ideally suited to long-term investors seeking an income stream, Mr Taylor said. The total expense ratio is 0.93pc and the fund yields about 5.3pc.

Rob Burdett and Gary Potter run the multi-manager arm of F&C. This means they spend their time evaluating funds of different types from a wide range of asset management companies.

However, among bond funds one of their current picks is run by their own company the F&C Macro Global Bond fund. It is a total return fund, so it aims to make gains from rising bond values as well as interest payments.

This fund has the brief, the track record and the strategy to profit through rising interest rates, primarily by taking positions in global government bonds and currencies, Mr Burdett said. It is run by Paul Thursby and Peter Geikie-Cobb, two highly regarded industry stalwarts.

His other choice was the M&G Global Macro Bond fund. This fund is run by Jim Leaviss, the head of the M&G bond team. He has given himself a fully flexible remit to profit from a wide range of economic conditions using assets including government bonds and currencies from around the world.

Brian Dennehy of FundExpert, the fund supermarket, also tipped the M&G Global Macro Bond fund. He said this was to exploit sterling weakness against the dollar but is not currency speculation.

He added: Our analysis shows that longer-term holdings of currencies are less volatile than low-risk corporate bond funds. The long-term outlook for the dollar looks positive against the pound and M&G Global Macro Bond is one of the few funds positioned to take advantage of this. Although a bond fund, the primary driver of performance will be currency.

Juliet Schooling Latter of Chelsea Financial Services said: We prefer strategic bond funds because of the much greater flexibility they have. This applies not only to which types of bond they can hold but also their to ability to manage the fund’s sensitivity to interest rate rises, which is largely done by managing how far the holdings are from their redemption date.

One of her recommendations was the City Financial Strategic Gilt fund. Ian Williams, the manager, has been very negative on gilts for some time. While this bearish view has hurt the fund in recent years, his ability to write gilt options on the underlying assets a way to profit from falling gilt prices has enabled him to outperform since tapering talk began.

Ms Schooling Latter also tipped the L&G Dynamic Bond fund. The manager, Richard Hodges, has a ‘total return’ mentality and views capital preservation as a first priority, she said. His holdings have a short average duration, although it has recently increased by a year to 3.7 years following the big sell-off in bonds ahead of the Fed’s announcement on Wednesday.

Some funds can even have a negative duration, thanks to the use of derivatives. One is the Old Mutual Global Strategic Bond fund, run by Stewart Cowley.

Ms Schooling Latter also tipped the Ignis Absolute Return Government Bond fund, which aims to make positive returns in all market conditions.

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