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Bond funds are popular with investors who want income, but many are vulnerable to interest rate rises. Experts identify the funds they think are safest

Many savers feel that investing in a fund that owns shares is too risky and opt for a bond fund instead. But choosing the right one has become a tougher task.

These funds, which in effect lend money to companies and governments in exchange for interest payments, have proved popular with savers looking for a reliable income from their retirement savings.

Since the financial crisis bond funds have performed well, but now the common view is that bonds have become expensive. This is particularly worrying for investors because bonds almost always perform poorly when interest rates are rising and rates are currently at rock bottom.

When the Bank of England does eventually raise the Bank Rate from 0.5pc, bonds are almost certain to be hit.

However, some types of bond, and bond fund, will suffer more than others. The safest option is seen as a “strategic bond fund”, where the manager has the flexibility to invest in any type of bond. Other types of bond fund are restricted to buying a particular variety of bond or those issued in a certain region, restricting their ability to choose bonds that are less susceptible to interest rate rises.

Here we ask investors who buy funds for a living to identify the bond funds that they think are best placed to protect savers’ money over the long term.

These bond funds are suitable for conservative savers and should be held as part of a diversified portfolio, with a mixture of other assets.

Average strategic bond fund performance over five years: 38pc (turning £10,000 into £13,800) (see graph). Over three years the average fund has returned 23pc (turning £10,000 into £12,300)

Source: FE Trustnet

= M&G Optimal Income =

This fund is a popular choice with financial advisers and fund shops, with more than £20bn in savers’ money to its name. This is because Richard Woolnough, the manager, is one of Britain’s most respected bond investors.

At present most of the fund’s money is in either “investment-grade” or “high-yield” corporate bonds. These bonds carry more risk than say a bond issued by the British Government, but offer higher yields to compensate.

Mr Woolnough’s top holdings include bonds issued by Lloyds Banking Group, Virgin Media and Thames Water.

Yield 3pc. Return over five years 47pc (turning £10,000 into £14,700).

= GLG Strategic Bond =

Like its M&G rival, the majority of this fund’s money is in either investment grade or high yield bonds.

But experts said the fund’s far smaller size, £960m, made it much easier for the manager, Jon Mawby, to buy and sell bonds quickly.

John Chatfeild-Roberts, who buys funds for Jupiter, put some of his clients’ money into GLG Strategic Bond at the beginning of this year.

“The fund is very aware of risk and exploits price discrepancies,” he said. “Its relatively small size gives Jon Mawby a certain manoeuvrability to duck and dive when markets are volatile, as they have been recently.”

Yield 3.4pc. No track record for five years; Return over three years 34pc, compared with 23pc for average fund.

= Henderson Strategic Bond =

Managed by John Pattullo and Jenna Barnard, this fund has one of the highest yields in the sector.

Not surprisingly, this means the fund managers mainly buy high-yield bonds. But experts say they pick those issued by reputable companies that are unlikely to default.

Gary Potter, who buys funds for F&C Investments, said: “The key to this fund is that the managers will not take unnecessary risks if they are not being sufficiently compensated for that risk. They have read the challenges of the bond market extremely well in recent years.”

Yield 5.4pc. Return over five years 35pc (turning £10,000 into £13,500).

= Invesco Perpetual Tactical Bond =

This fund is another of Mr Potter’s favourites. It is managed by respected investors Paul Causer and Paul Reid, who hunt for value and buy bonds that most other investors are avoiding.

In 2011, for instance, they invested a quarter of the fund in Spanish and Italian government bonds, which at the time were yielding more than 6pc amid fears that the countries were close to bankruptcy.

But the managers felt that both states were “too big to fail” and were proved correct.

Mr Potter said: “The managers also benefited from buying cheap bank debt several years ago and I believe in the coming years will once again move the portfolio around to capture the best opportunities in an increasingly tough environment for bond investors.”

The fund does not have an income target and is not really suitable for investors looking for income.

Yield 0.7pc. No track record for five years; Return over three years 37pc, compared with 23pc for average fund.

= Twenty Four Income =

This fund aims to yield between 5pc and 6pc while delivering a “total return” including capital gains of 7pc to 10pc each year. Experts say they are confident that these targets can be achieved.

The fund buys mainly complex bonds called “asset-backed securities”, which are often riskier than bonds issued by governments or companies but can offer rich rewards.

Unlike the other funds listed here it is an investment trust and therefore has shares listed on the London Stock Exchange (Other OTC: LDNXF — news ).

At present the fund’s shares are trading at a 6pc “premium”. This means investors who buy today are paying more than the fund’s underlying assets are worth.

But Tom Becket, who buys funds for Psigma, said it was worth paying a bit extra. “The assets the fund owns are undervalued and are likely to appreciate markedly in the future, so the premium is worth paying,” he said.

Yield 4.9pc. This fund listed in March 2013 so does not have a long track record. Over the past year it has returned 17pc, compared with 6pc for the average strategic bond fund.

Please note: The yield figures quoted are the distribution yields, which is the amount that are expected to be paid out over the next twelve months. The figures were provided by Hargreaves Lansdown (LSE: HL.L — news ). the broker.

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